The roll-out of Ind AS in a phased manner will bring in inconsistency in the accounting standards being followed by various companies. This will pose significant practical challenges in undertaking economic analysis, which is a fundamental part of any transfer pricing analysis.
In recent years, the use of International Financial Reporting Standards (IFRS) as a common language for financial reporting has gained wide acceptance in almost 140 countries across the globe. In 2015, the Ministry of Corporate Affairs (MCA) notified the roadmap for the implementation of Indian Accounting Standards (Ind AS), which are substantially converged with IFRS.
The phase-wise adoption of Ind AS, which began from 1 April 2016, has a significant impact across industries such as IT services/technology, pharmaceuticals, infrastructure and telecom. Companies analysed in PwC’s Ind AS impact analysis reported an increase in revenues of 26.5 per cent.
Revenue and Expense Accounting
Revenue is one of the most important financial statement measures for both preparers and users of financial statements. Currently, Accounting Standard 9, ‘Revenue recognition’ under IGAAP does not provide comprehensive guidance on certain aspects, resulting at times in a diversity of accounting practices. Ind AS 18, ‘Revenue’, provides comprehensive principles for recognising revenue, which will affect mostly all companies that apply Ind AS.
Some of the key differences in revenue accounting between IGAAP and Ind AS are multiple element arrangements, linked transactions, gross versus net presentation (excise duty, etc.), presentation of revenue net of discounts, volume rebates, incentives to customers, treatment of financing benefits, extended warranties, etc. On the expense side, certain changes in Ind AS will result in reporting of higher expenses upon adoption of Ind AS. For example, the mandatory disclosure of excise duty in the cost will lead to an increase in the reported revenue of companies under Ind AS, as under IGAAP, excise duty was netted off against the revenue.
Further, unlike IGAAP, the Ind AS income statement is prepared under two parts—one is the component of the statement of profit and loss and the other is other comprehensive income (OCI). The components of OCI are items of income and expense (including reclassification adjustments) that are specifically required or permitted by other Ind AS to be included in OCI and are not recognised in profit and loss. Together, profit and loss and OCI make up the total comprehensive income.
Key Impact Areas
Ind AS implementation in India will be undertaken in a phased manner. As per the database of 2017, out of the 10,459 companies (excluding insurance, banking and non-banking finance companies), approximately 10 per cent will fall under Phase I and 32 per cent under Phase II. The remaining 58 per cent are presently not under Ind AS Phase I and Phase II transition.
PwC’s Ind AS impact analysis report revealed that a majority of Ind AS adjustments were on account of taxes, financial instruments and revenue recognition. Additionally, retirement benefit obligations, share-based payments, and business combination and consolidation were also identified to be common Ind AS adjustments.
Ind AS with its focus on substance and transparency impacts taxation, including transfer pricing (TP), corporate governance, internal controls and stakeholder communication. Under Ind AS, there will be a change in accounting treatment of items such as extended warranty on sales, financing benefit on sales, discounts, volume rebates, sales incentives, share-based payments, impairment of intangibles, etc. Companies will have to undertake a thorough analysis to assess whether the TP treatment of such items as operating or non-operating will undergo a change from the TP perspective. Consequently, advance pricing agreements (APAs) are also likely to be impacted as Ind AS may impact the underlying TP methodologies and critical assumptions.
The implementation of Ind AS will result in inconsistent accounting standards being followed by various companies. Some companies will continue to follow Indian Generally Accepted Accounting Principles (IGAAP), while others will transition to Ind AS. This will pose significant practical challenges in undertaking economic analysis, which is a fundamental part of any TP analysis.
Certain arrangements may be accounted for differently under Ind AS than before—for instance, the gross margin earned by a stripped risk distributor (SRD) may be accounted for as service income, or an arrangement that conveys a right to use an asset in return for a series of payments (but which does not take the legal form of a lease) may be accounted for as a lease, etc. This will have a TP impact as well. Under Ind AS, financial instruments such as redeemable preference shares, perpetual debentures, etc., may be re-characterised from equity to debt or vice versa. Ind AS may also lead to enhancement of scope of related parties. Both of these will need a TP impact analysis.
Ind AS has brought about certain significant changes in the recognition and presentation of various items in the financial statements. The concept of fair valuation is now extensively applied. These changes are in line with the global standards.
During the transition years, the change in the disclosure and accounting norms may have seemed overwhelming. However, the key to an appropriate analysis would be to adhere to the basic principles of TP. By analysing various parameters such as the underlying nexus of the income/expense with business operations and notional or cash income/expense, companies will have to undertake a thorough analysis to determine whether or not the change in revenue/expense accounting is operating in nature from the TP perspective.