KPMG: New accounting standards may make debt instruments costlier
March, 25th 2011
The adoption of new accounting standards in line with International Financial Reporting Standards, or IFRS, may increase the cost of raising debt through instruments such as debentures, preference shares and foreign currency convertible bonds (FCCBs) as the rules get tighter.
Last month, the ministry of corporate affairs or MCA issued 32 IFRS convergent accounting standards under the nomenclature Ind-AS (for India accounting standards).
Ind-AS was to have been adopted from the quarter starting 1 April but deadlock between the finance ministry and MCA over tax issues under the proposed regime has led to a delay. Companies are, however, preparing for the new standard.
In the post-Ind-AS regime, some financial instruments may lose their attractiveness due to the adverse impact on financial statements, said Jamil Khatri, executive director and head of accounting advisory services at KPMG in India. Several of these instruments are commonly used for financing by Indian companies.
Currently, under Indian Gaap (generally accepted accounting principles), issuers of the instruments enjoy certain advantages. These include avoiding charges to the profit and loss account of part of the returns on these instruments and delaying the adverse impact on net worth by recognizing the redemption premium only at the time of such redemption.
IFRS are balancesheet driven standards which are more than likely to create volatility in the year-to-year income statements and that is a hard reality which the Indian companies will be confronting with convergence, said Manoj Daga, national head, Global Knowledge Services, BDO.
In the case of debentures, under Ind-AS, the redemption premium plus coupon interest are amortized to the profit and loss account over the term of these instruments based on the Effective Interest Rate (EIR) method, Khatri said.
Therefore, under Ind-AS, profitability of the issuers of these instruments would get adversely impacted due to the increase in interest costs, he added.
Currently, under Indian GAAP, the premium on redemption of debentures is mostly adjusted against the securities premium account, either during the term of these instruments or on the date of redemption. Therefore, there is no charge to the profit and loss account and earnings per share is not affected.
Current standards are loose enough to allow companies to use such instruments as per the form rather than substance because of overriding local regulations,Daga said. The new regulations will ensure stricter compliance with norms, he said.
He cited the example of compulsorily redeemable preference shares, which are presented as part of share capital currently, with coupons being paid out as dividends.
Under IFRS, these instruments will be treated as financial liabilities, with the coupon being charged off in the income statement, Daga said.
There is some debate over the effect of Ind-AS on FCCBs. Rahul Chattopadhyay, partner at Price Waterhouse, a unit of PricewaterhouseCoopers, said the effect wont be drastic.
Since the derivative component will be treated as equity and not debt, its good for corporates,he said. This is one exclusion that has been made in Ind-AS, he said.
Khatri has a different view.
Under Ind-AS, FCCBs are generally referred to as compound financial instruments and are initially split into the borrowing and equity components, he added.
The borrowing component is initially measured at the present value of future cash flows discounted at a rate applicable to similar instruments without a conversion feature. The amount allocated to equity component is the residual, Khatri said.
Under Indian Gaap, companies treat accounting for redemption variously. While some amortize the premium, others treat it as a contingent liability till the redemption date.
Companies will learn to live with the new rules, since they always need to raise capital, Chattopadhyay said.