Impact on Banks and NBFC due to conversion into Ind AS standards

Features of RBI circular:

Banks shall comply with Ind AS for financial statements for accounting
periods beginning 1 April 2018, with comparatives for the periods ending 31
March 2018 or thereafter. Ind AS shall be applicable to both standalone
financial statements and consolidated financial statements.
Banks need to submit pro forma Ind AS financial statements to the RBI from
the half-year ended 30 September 2016 onwards.
Banks are advised to set up a Steering Committee headed by an official of
the rank of an executive director (or equivalent), comprising members from
cross functional areas of the bank to immediately initiate the implementation
process.

Critical Areas

Financial Instruments

Investments are classified into the following categories: held to maturity,

available for sale and held for trading. Investments in the shares of
subsidiaries are classified under the held to maturity category.
According to the current guidelines, net loss in the available for sale and held
for trading classifications is computed category wise and recognized in the
profit and loss account while net gains are ignored.
As per Ind AS 109, all financial assets will have to be classified at amortized
costs, fair value through other comprehensive income (FVOCI) or FVTPL. The
above classification would be based on the business model test and the
contractual cash flow tests.
All unrealized gains or losses for financial assets classified at FVOCI income
would be accounted for in the other comprehensive income and on assets at
fair value through the profit and loss in the profit and loss account.

Impairment of Financial Instruments

Ind AS 109 requires entities to recognize and measure a credit loss allowance
or provision based on an expected credit loss model.
The new impairment model based on the expected credit losses as compared
to percentage-based provisioning norms will have a significant impact on the
systems and processes of entities because of its extensive requirements for
forwarding - looking probabilities of default along with data and calculation.

Consolidated Financial Statements

Ind AS 110 establishes a single control model for all entities (including special
purpose entities, structured entities and variable interest entities). The
implementation of this standard will require managements to exercise
significant judgment to determine which entities are controlled and therefore
 are required to be consolidated. It changes the assessment of whether an
entity is to be consolidated, by revising the definition of control.

Business Combinations

Ind AS 103 will apply to all business combinations, including amalgamations.

Once Ind AS 103 is effective, all assets and liabilities acquired will be
recognized at fair value.
Additionally, contingent liabilities and intangible assets not recorded in the
acquirees balance sheet are likely to be recorded in the acquirers balance
sheet on acquisition date.
Ind AS 103 prohibits amortization of goodwill arising on business
combinations, and requires it to be tested for impairment annually. Indian
GAAP requires amortization of goodwill in the case of amalgamations. Indian
GAAP provides no guidance on goodwill arising on acquisition through equity.

Property, Plant and Equipment

Ind AS permits an entity to use carrying values of all property, plant and
equipment as on the date of transition to Ind AS, in accordance with the
previous GAAP, as an acceptable starting point under Ind AS. IFRS does not
provide a similar option on first-time adoption.

Key Focus Areas and their Impacts

Income

Effective Interest Rate

Under the existing Indian GAAP, loan-processing fees are recognized upfront
in the profit and loss account and costs relating to origination of loans are
debited to the profit and loss account.
Under Ind AS, these fees will be amortized over the life of the loan using the
effective interest rate method.
Under Indian GAAP, service charges, fees and commission income are
generally recognized on due basis.
Under Ind AS, fees that are an integral part of the effective interest rate of a
financial instrument are treated as an adjustment to the effective interest
rate, unless the financial instrument is measured at fair value, with the
change in fair value being recognized in profit or loss. In those cases, the fees
are recognized as revenue or expense when the instrument is initially
recognized.

Interest Income on Non-performing Assets

Under Ind AS 109, interest income is generally recognized on effective

interest rate on the gross carrying amount of financial assets depending on
 the stage in which the loan is. In the case where the loan or an asset is
considered impaired, the interest income will be accounted for at the net
amount, i.e., gross carrying amount less provisions made.

Relevant date for recognition of gains/ losses on dealing with securities

Under Indian GAAP, the RBI requires gains and losses on the sale of
Government securities to be recognized on the settlement date.
Ind AS 109 allows a company to recognize gains and losses on dealing with
securities on either the trade date or the settlement date.

Accounting for customer loyalty programs

Under Indian GAAP, a bank does not separately account for income from
customer loyalty programs. The bank provides for liability toward these
reward points byestimating the probability of redemption of customer loyalty
reward points .
Under Ind AS, award credits under customer loyalty Programs are accounted
for as a separately identifiable component of the transaction in which they
are granted. Income generated from customer loyalty programs is recognized
as other operating income.

Sale of NPAs

The extant RBI guidelines provide for the deferment of recognition of

gains/losses (sale to reconstruction companies [RCs] or securitization
companies [SC]) as well as the non-recognition of gains (where sales are
made to non RCs/SCs).
The accounting treatment for such sales would be governed by the de-
recognition criteria specified under IND AS 109. If the criteria for de-
recognition is met then, the gains would be recognized upfront.

Impact on Financial Reporting

The accounting for the unrealized gains or losses on investments accounted

at FVTPL as per the business model adopted by the bank would also
introduce some amount of volatility in the profit and loss account.
The accounting for interest income on an effective interest rate basis would
have an impact on the net interest income and the corresponding interest
spreads and margins reported by banking entities.

FINANCIAL INSTRUMENTS

1) Classification and measurement

Classification as debt or equity

Under Ind AS 32, mandatorily redeemable preference shares on which a fixed

dividend is payable are treated as a liability. Under extant Indian GAAP,
classification is normally based on form rather than substance.
In the context of banking in India, there could be an impact in terms of
classification for certain quasi equity and subordinated debt type instruments
such as perpetual debt instruments (PDI) and perpetual non-cumulative
preference shares (PNCPS) issued as a part of tier I or tier II capital.
Ind AS 32 requires compound financial instruments, such as convertible
bonds, to be split into liability and equity components, and each component
to be recorded separately. Extant Indian GAAP entails no split accounting, and
financial instruments are classified as either liability or equity, depending on
their primary nature.

Classification of financial assets

Ind AS 109 contains three classification categories for financial assets: a)

Amortized cost, b) FVOCI, c) FVTPL

Classification of financial liabilities

Under Ind AS 109, all financial liabilities are classified into two categories:
FVTPL and other financial liabilities. The initial measurement of all financial
liabilities is at fair value.
Subsequent to initial recognition, FVTPL liabilities are measured at fair values,
with gain or loss (other than gain or loss attributable to own credit risk)
being recognized in the income statement. Gain or loss attributable to own
credit risk for FVTPL liabilities is recognized in equity.
Other financial liabilities are measured at amortized cost using the effective
interest rate for each balance sheet date.
Earlier, The common practice is to recognize the financial liability for
consideration received on its recognition. Subsequently, interest is recognized
at the contractual rate, if any.

2) Accounting for derivatives

Ind AS 109 defines a derivative as a financial instrument or a contract having

the following three characteristics:
Its value changes in response to the change in a specified interest rate, financial
instrument price etc.
It requires no or smaller initial net investment.
It is settled at a future date.
As per Ind AS 109, all derivatives, except those used for hedging purposes,
are measured at fair value, and any gains/losses are recognized in profit or
loss.
Market transactions done by banking entities are marked to market (at least
at fortnightly intervals), whereas those for hedging purposes could be
 accounted on an accrual basis. This accounting treatment for IRS under the
extant circular is different from Ind AS 109, which requires all the derivatives
to be categorized as FVTPL. Even the hedging accounting model under Ind AS
109 is at variance with the extant circular.

3) De-recognition

Because of the strict criteria for derecognizing financial assets in Ind AS 109,
some financial asset disposal transactions (particularly during the sale of
loans or trade receivables) may be reclassified as guaranteed loans.

4) Comprehensive disclosures
5) Impairment

Ind AS 109 has introduced a new expected credit loss (ECL) model for the
impairment of financial assets. It applies to financial assets that are not
measured at FVTPL, including certain bank deposits, loans, lease and trade
receivables, debt securities, and specified financial guarantees and loan
commitments issued.
Under the extant IRACP norms, the provisioning is based on objective criteria
fixed by the RBI, which are based on the 90-day past-due concept for banks
and 180-day past due concept for NBFCs. The provisioning requirements are
based on the period for which the asset has remained nonperforming and the
security available.

Impact of Impairment on Financial Reporting

The proposal may increase the credit loss allowance or provisions

recorded by banking entities.
Business combinations

Ind AS 103 provides an option to measure any noncontrolling (minority)

interest in an acquiree at its fair value, or at the non-controlling interests
proportionate share of the acquirees net identifiable assets. Under Indian
GAAP, AS 21 does not provide the first option. It requires a minority interest
in a subsidiary to be measured at the proportionate share of net assets at
book value.
Ind AS 103 requires that, in a business combination achieved in stages, the
acquirer remeasures its previously held equity interest in the acquiree at its
acquisition date fair value. The acquirer is to recognize the resulting gain or
loss, if any, in profit or loss.

Impact on Financial Reporting

Assets and Liabilities will be recorded at fair value. Contingent liabilities and
intangible assets will be recorded at fair value in the acquirers balance
sheet.
In acquisition done in stages, goodwill will change significantly and will
project the actual premium paid by the entity.
 Amortization and Depreciation of net assets will be taken over at fair value
and not on the carrying value.

Income taxes

AS 22 Accounting for Taxes on Income is based on the income statement

liability method, which focuses on timing differences. Ind AS 12 Income Taxes
is based on the balance sheet method, which focuses on temporary
differences. One example of the temporary vs. timing difference approach is
revaluation of fixed assets. Under Indian GAAP, no deferred tax is recognized
on upward revaluation of fixed assets where such revaluation is credited
directly to the revaluation reserve. Under Ind AS, companies will recognize
deferred tax on revaluation component if the other recognition criteria are
met.
Under Ind AS, an entity should recognize a deferred tax liability in
consolidated financial statements for all taxable temporary differences
associated with investments in subsidiaries, branches and associates, and
interests in joint ventures e.g., undistributed profits except to the extent
that the parent, investor or venturer is able to control the timing of the
reversal of the temporary difference and it is probable that the temporary
difference will not reverse in the foreseeable future. Under Indian GAAP,
deferred tax is not recognized on such differences.
Disclosure required for income taxes is likely to increase significantly on
transition to Ind AS. The following are examples of certain critical disclosures
mandated in Ind AS: an explanation of the relationship between tax expense
(income) and accounting profit; an explanation of changes in the applicable
tax rate(s) compared to the previous accounting period; and the amount (and
expiry date, if any) of deductible temporary differences, unused tax losses,
and unused tax credits for which no deferred tax asset is recognized in the
statement of financial position.

Employee benefits and share-based payments

Ind AS 19 Employee Benefits requires the impact of remeasurement in net

defined benefit liability (asset) to be recognized in other comprehensive
income. Remeasurement of net defined liability (asset) comprises actuarial
gains or losses, return on plan assets (excluding interest on net asset/liability)
and any change in effect of asset ceiling. Indian GAAP currently requires such
impacts to be taken to the profit and loss account.
Under Ind AS, employee share-based payments should be accounted for
using the fair value method. In contrast, Indian GAAP permits an option of
using either the intrinsic value method or the fair value method. This even
applies to share-based payment to non-employees.
Under Ind AS 102, such ESOPs will have to be accounted as per principles laid
down in Ind AS 102, i.e., either as equity-settled or as cash-settled plans,
depending on specific criteria. As per Ind AS 102, a receiving entity whose
employees are being provided ESOP benefits by a parent will have to account
for the charge. This will reflect the true compensation cost of receiving
employee benefits.
Impact on Financial Reporting

It will reduce the volatility in Profit and Loss account due to accounting
of actuarial gains/losses recorded in other comprehensive income.
Due to ESOPs measurement in fair value as compared to the intrinsic
value, it will charge higher ESOPs and will affect profitability ratios.
Since, the subsidiary will now have to account the ESOP (if received by
parent) in their statements, it will reflect the true compensation cost.
Ind AS 19 and Ind AS 102 may have opposite effects.

Property, plant and equipment, intangible assets and leases

Ind AS 16 Property, Plant and Equipment mandate component accounting,

whereas AS 10 recommends but does not require it. However, the Companies
Act will require companies following AS 10 to apply component accounting
mandatorily from financial years commencing 1 April 2015.
Major repairs and overhaul expenditure are capitalized under Ind AS 16 as
replacement costs, if they satisfy the recognition criteria. In most cases,
Indian GAAP requires these to be charged off to the profit and loss account as
incurred.
Any change in the depreciation method is treated as an accounting policy
change under Indian GAAP, whereas it is treated as a change in estimate
under Ind AS.

Impact on Financial Reporting

Since, major repairs are being capitalized, it will be removed from the income
statement, thereby increasing the net income situation and profitability
ratios.
Now, the cost of an asset will include dismantlement, removal or restoration
which will be added to the purchase price at initial recognition.
Impact on the revaluation model: if applied then have to revalue the whole
asset class and not the selective class.
No amortization is required for intangible assets; hence entities will be able to
project the real values of the intangible asset in the balance sheet.

Presentation of financial statements

Ind AS 1 requires the presentation of a statement of comprehensive income

as part of financial statements.An entity is required to present a single
statement of profit or loss and other comprehensive income presented in two
sections. The sections will be presented together, with the profit or loss
section presented first followed directly by the other comprehensive income.
 Under Ind AS 1, minority interest (referred to as non-controlling interest) is
presented as a component of equity, while under the current Indian GAAP it is
presented separately from liabilities and equity.
Ind AS 1 prohibits any item to be presented as an extraordinary item, either
on the face of the income statement or in the notes, while AS 5 Net Profit or
Loss for the Period, Prior Period Items and Changes in Accounting Policies in
Indian GAAP specifically requires disclosure of certain items as extraordinary
items.
Ind AS 1 requires the presentation of all transactions with equity holders in
their capacity as equity holders in the statement of changes in equity
(SOCIE). The SOCIE is considered to be an integral part of financial
statements. The concept of SOCIE is not there under current Indian GAAP.
Ind AS 1 requires dividends recognized as distributions to owners and related
amounts per share to be presented in the statement of changes in equity or
in the notes. The presentation of such disclosures in the statement of profit
and loss is not permitted. Under Indian GAAP, a proposed dividend is shown
as appropriation of profit in the profit and loss account.

Related party disclosures

Ind AS 24 requires disclosure of key management personnels compensation

in total and for certain specified categories, such as short-term employee
benefits and post-employment benefits. AS 18 does not have such a
requirement.

Segment reporting