Born-Again Balance Sheets

Come 2011 and the manner in which Indian companies present their profit and loss accounts (P&L) and balance sheets will change significantly. That is when  it will become mandatory for them to adopt the International Financial Reporting Standards (IFRS). Here is a quick guide to surviving that transformation.

PROFIT & LOSS ACCOUNT
Deferred Revenue: Currently, a telecom company selling a connection can immediately account the activation charges as revenue, even though they will be paid by the subscriber only after a month. This is called deferred revenue recognition. IFRS prohibits that. A company can account only for revenues that it gets in hand.

ESOP Valuation: IFRS will usher in significant changes in expenditure accounting. For instance, when companies issue employee stock options, they currently follow the “intrinsic value” method. It will change to “fair value” method. This is expected to reflect the real cost of ESOPs including the impact of market volatility.

 

 

Illustration: Malay Karmakar

Preference Shares: Dividends on redeemable preference shares were so far accounted as appropriation from the profits. With IFRS, they would be classified as a liability payment. This will pull down the net profit figure.

BALANCE SHEET
Mergers & Acquisitions: When a company acquires another, it not only pays for the book value of the firm, but also a premium for the business potential. Current balance sheets consider anything above book value to be goodwill payment, while IFRS gives a considerable leeway to the acquirer to determine the fair value of the assets before coming to the goodwill portion. This is aimed at attaching a more updated value to the business.

Current Liabilities: Companies face situations when a long-term liability suddenly becomes due shortly. For instance, if a company violates debt covenants, the lender has the right to ask for immediate payment of a long-term loan. Current norms don’t account for such changes. IFRS will reveal any such changes. The result is more transparency.

Length: Dr Reddy’s latest financial statements consist of only 40 pages published according to the Indian norm. Under IFRS, the page count reaches 84. The reason? Extensive disclosures. Every small change that can potentially affect the company should be spelt out under IFRS.

Fluctuating Numbers: The IFRS rule linking the value of things like financial assets to their current market value will lead to the numbers fluctuating from quarter to quarter. This could be disconcerting to the investor used to reading the steady “value-at-cost” numbers. In a way, this is the most fundamental change that an Indian investor must adapt to under the new system.