Impact of IFRS
on
Housing Finance Companies
29th CEO’S Meeting of HFCs
Presentation By Mr Keki Mistry
March 17, 2010
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Contents
• Fundamental difference between IFRS and Indian
Accounts
• Proposed Convergence Path
• Regulatory Alignment
• Significant Impacts for HFCs
2
Fundamental Difference
between IFRS and Indian Accounts
• Indian Accounts are prepared on the basis of
historical cost and prudence
• IFRS reports certain item of Assets and Liabilities at
Fair Value and not at Original Cost
3
Proposed Convergence Path
• Commencement date 1st April 2011 reiterated by MCA
• Phases suggested by MCA for convergence
• Phase 1: Nifty 50 and Sensex 30 companies, Companies listed outside
India, Companies with over Rs 1000 crore networth
• Phase 2: All companies (listed and unlisted) with networth between Rs
500 crores and Rs 1000 crores
• Phase 3: All listed companies with networth below Rs 500 crores
• Changes proposed in Companies Act sent to MCA
• 2 set of Accounting Standards suggested
• 1st set that converge with IFRS
• 2nd set that carries the existing standards
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Regulatory Alignment
• Income Tax Act
– Treatment of Fair Value gains and losses
– Impact of Fair Value changes for Asset Based Taxation
• NHB Regulations
– Guidelines on provisioning and income recognition
• Companies Act
– Amendments suggested for Schedule VI and XIV
– Certain Sections are also being amended
• Accounting Standards
– Most significant change in the standard on Financial Instruments
• Derivatives
• Investments – Fixed Income and Equity
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Changes in the Companies Act - 1
• Dividend (Section 205)
– Allows Dividends out of PROFITs for the year
– Under IFRS certain PROFITs may go to Reserves
• Legal confirmation for certain transactions
– Amalgamation and Reconstruction require ratification by the
courts/ tribunals (Sections 391 to 394) before they can be
incorporated into the accounts
– Under IFRS, date of acquiring the control is the trigger point
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Changes in the Companies Act - 2
• Funding growth thru debt (Section 78)
– Premium on Redemption of Debentures is allowed to be debited
to Share Premium
– Under IFRS this has to be debited to P&L
• Treasury Stock
– Buyback of its own stock leads to reduction in the capital of the
company (Section 100)
– Under IFRS this is permitted to be held as Treasury Stock
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Changes in the Companies Act - 3
• Other Comprehensive Income
– This concept does not exists in Indian Accounting
– Under IFRS, certain Income and Expenses are recognised
directly in Shareholder’s equity under the head Other
Comprehensive Income e.g. Fair value changes in equity/
derivatives
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Changes in Schedules
(under Companies Act)
• Depreciation (Schedule XIV)
– Useful life is limited by the Act, higher life not allowed
– Under IFRS, useful life is a management estimate
• Presentation of Income Statement (Schedule VI)
– Currently as per specified format
– Under IFRS no format is prescribed
• Presentation of Balance Sheet (Schedule VI)
– Formats specified. Specific formats for Banks and Insurance
– Under IFRS, items are classified into Current and Non Current
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Accounting for Derivatives
• Derivatives have to be Fair Valued (FV)
• MTM Gains and Losses recognised in PL unless proved as hedge
• Hedge is proved if [Change in FV of Underlying ÷ Change in FV of derivative]
lies between 0.80 and 1.25
• Mathematical proving may be difficult even though economically valid
• If effectiveness proved:
• Net difference between FV of Underlying and Derivatives is taken to PL
• If not proved :
• MTM effect of Derivatives taken to PL, Underlying remain at Amortised Cost
• This can cause huge unwarranted volatility
• Intention to hold the derivative till maturity does not have an
impact
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Example of Forward Contract
•
A company borrows USD 100 mio @ Rs 48/ USD (Rs 480 crores) for a 5 year period
•
Loan hedged on same day through a forward contract at Rs 53.00 (Forward premia Rs 5)
•
Currently Rs 5 is amortised over the life of the loan @ Rs 10 crores per year
•
Under IFRS this would happen:
•
As on next reporting date :
– USD/INR spot rate
: 45.50
– Forward Rate for balance to maturity period
: 49.00
– Gain on Loan Revaluation (100 mio * 2.50)
: Rs 25 crores
– Mark to Market Loss on Forward Contract (100 mio * 4.00): Rs 40 crores
•
Mathematical ratio 0.625 (25 ÷ 40) does not prove effectiveness on the reporting date
•
Net Ineffectiveness : Rs 15.00 crores debit to Profit and Loss Account in this method
•
The total debit to PL will be Rs 50 crores over 5 years under both methods
– The periodic allocation under current accounting is smooth
– While the periodic allocation under IFRS is volatile
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Amortisation and Impairment
• Amortisation of loans to be done based on effective rate
– Loan Fees and Costs (e.g. DSA commission) would get deferred
• Impairment
– General impairment based on Statistical models of Default
Probability and Expected Loss
– Specific impairment for significant items based on present value of
expected Cash Flow
– Impairment amounts likely to be lower than current regulatory
guidelines
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Investments and Capital Requirement
• Investments in Equity Shares
– Other than Subsidiaries and Associates
• These would be Fair Valued
• Fair Value differences can be either through PL or into Reserves
• If routed into Reserves, the final gain/ loss would also go into Reserves
– Investment in Subsidiaries and Associates
• Either the above method can be used or these can be valued at cost
• Capital Requirements
– Volatility due to changes in Fair Valuation
– Credits to Reserves – are these Tier 1 capital ?
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Staff Loans
• These would get Fair Valued using the market rates
• This would adversely impact the 1st year PL
Loan
Term (in months)
Rate
EMI
Market Rate
Present Value of EMIs (PV of 5059 * 240 months)
1st Year Debit to PL (10,00,000 – 5,24,237)
10,00,000
240
2.00%
5,059
10.00%
5,24,237
4,75,763
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ESOPs and Interest Free Deposits
• ESOPS
– The option would get Fair Valued and charged as a Cost
– Option of Intrinsic value is not available
• Interest Free Deposits (for Rent etc.)
– Similar to Staff Loans – would get fair valued with initial loss
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Thank You
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