Applicability of Ind AS on Banks & Financial Institutions
The Ministry of Corporate Affairs (MCA), in January, 2016, had notified the roadmap for implementation of Indian Accounting Standards converged with International Financial Reporting Standards (IFRS) for Scheduled commercial banks (excluding RRBs), insurers/insurance companies and Non-Banking Financial Companies (NBFCs).
NBFCs are required to prepare Ind AS financial statements (both consolidated and standalone) in two phases:
Phase I Applicable from 1st Phase 1 April, 2018 onwards to following NBFCs
Phase II Applicable from 1st Phase 1st April, 2019 onwards to following NBFCs
However, RBI through its notification dated March 22, 2019 has deferred the implementation of Ind AS to all scheduled commercial banks till further notice.
Impact on Financial Statements of Banks and Financial Companies
Ind AS will bring about a major change in the financial statements of banks and financial companies. Apart from financial figures, presentation and disclosure, one major impact will be on financial ratios such as NPA ratio, current ratio. The migration impact will be majorly due to provision for expected credit loss (ECL), application of effective interest rate (EIR), valuation of derivatives, investments valuations, recognition of employee cost and deferred tax.
Expected Credit Loss (ECL)
Financial Institutions shall measure Expected credit loss of financial instruments (Loans, trade receivables, etc.) as per Ind AS 109 – Financial Instruments which states that ECL should be measured considering the following:
ECL considers the amount and timing of payments, a credit loss arises even if the entity expects to be paid in full but later than when contractually due.
Effective Interest Rate (EIR)
Borrowing cost now needs to be recognized based on Effective Rate of Interest of Borrowing at Amortised Cost. The effective annual interest rate is the interest rate that is actually earned or paid on an investment, loan or other financial product. The transaction costs such as processing fees, stamp duty, commission are required to be amortised over a period of time along with the cost of borrowing. Under Indian GAAP, in the absence of any specific guidance, these were either accounted upfront or amortised over the contractual term of the instrument.
The current accounting GAAP are silent for the treatment of derivative contracts other than forwarding contracts, Ind AS 109 requires recognition of all derivative contracts on the mark to market basis. Due to no “Prudence” approach, the accounting of derivative contracts requires recognition of both losses and gains on mark to market basis under Ind AS 109, whereas under IGAAP only losses were recorded. A positive impact of the same can be seen in the bottom line on financial statements of financial Institutions (FIs) because financial instruments form a major part of the balance sheet of FIs.
Derecognition of Financial asset
As per RBI guidelines, FIs are required to transfer their financial assets (loans) through the partial assignment route and accordingly derecognises the transferred portion as it neither has any continuing involvement in the same nor does it retain any control. If the FIs retain the right to service the financial asset for a fee, it is required to recognise either a servicing asset or a servicing liability for that servicing contract. A service liability in respect of a service is recognised at fair value if the fee to be received is not expected to compensate the FIs adequately for performing the service. If the fee to be received is expected to be more than adequate compensation for the servicing, a service asset is recognised for the servicing right.
Other Areas of Impact
A new Era of Accounting
Seeing the larger picture, with Indian Accounting Standards applicable for various categories of companies and NBFCs, financials of Indian Companies have significantly increased comparability with global companies. The confusion for users of financial statements will be reduced drastically due to similar accounting framework. Indian Accounting Standards are a way ahead towards globalisation of the business world.