Money Bol » IFRS Valuation

BGR Energy: Building the Indian Power Story

Praveen Bajaj — Wed, 24 Mar 2010 11:19:39 +0000

Last week I heard a very interesting story which eventually gave me the idea of investing in BGR Energy Systems Ltd. Thought of sharing with you.

Years back when the South African Government opened their country for outsiders to come and do mining for diamonds, entrepreneurs form all over the world rushed to South Africa in the hope of finding diamonds and changing their fortunes. Of them only very few were able to do so and become rich. But there was one African business man who instead of joining this rat race to discover diamond started the business of selling/renting hammers and other mining material whoever was coming to discover diamond. He eventually became a millionaire and one of the most successful entrepreneurs of this Diamond run.

I hope some of you must have realized the point I am trying to put here. In India currently most of the companies are running to set up the power plant to generate power and other half are running to build the great power generating turbines or boilers. But very few are there in the business of building the Balance of Plants (BOP) which accounts for more than 35% of the total money spent in building up a power plant.

Thus, I strongly believe that there is a huge potential in this sector and BGR energy being the undisputed leader with a strong order book and execution track record offers great long term investment opportunity.

I would recommend one to start a SIP form of investment in this stock for a minimum of 2.5-3 years period, since at the current levels investing lump sum might be a little dangerous given the market conditions.

Happy Investing…!!
Author: Rahul Sonthalia, Analyst, Kredent Group

Comparison of IFRS and Indian Accounting Standards

Praveen Bajaj — Tue, 23 Mar 2010 07:08:43 +0000

IFRS is a novel way of looking at accounting. IFRS is a “principle-based” standards rather than “rule-based” standard which are currently followed.

Under IFRS there is need to apply professional judgment consistent with intent and spirit of standards.

Various countries have adapted to IFRS in different ways, often embedding local cultures and that is why there are no standard rules; only broad principles which define the outer boundary of accounting.

IFRS fixed assets rules questions valuation on historical cost basis, questions application of uniform rates of depreciation on all components of a fixed asset as also the amortization of intangible assets such as goodwill or patents.

In IFRS off-balance sheet transactions had been made as part of accounts; it brings a whole new meaning to the reported numbers.

It defines control of entities not through percentage of holdings but by the decision-making power inherent in the parent company.

Top management has, thus, to work out new targets of earnings depending on the direction of impact caused by the new accounting principles and recognising the IFRS GAAP differences.

Earnings will no more be a steady figure that can be easily targeted depending as it is not just on sales and expenses but also changes in asset values and the ability to measure those correctly.

To be adequately prepared for IFRS, senior management has to also shape up by analyzing which management models and strategies will work best for their organizations facing a huge level of turbulence and thus should prepare an IFRS roadmap.

Financial statement will include:
• Consolidated Income Statement
• Consolidated Statement of other comprehensive income
• Consolidated Balance sheet
• Consolidated statement of changes in equity
• Consolidated cash flow statement

Comprehensive Income includes the following:
• Profit/Loss for the year from Continuing Operations
• Profit/Loss for the year from Discontinuing Operations
• Other Comprehensive income
- Exchange differences in translating foreign operations
- Gain/Loss on fair value changes in AFS financial instruments, Cash Flow hedges
- Actuarial Gain/Loss on Defined benefit pension plans
- Share of other comprehensive income of Associates
- Income tax relating to items of other comprehensive income
• Total Comprehensive Income for the year

In Indian GAAP the Balance Sheet format is to start with Liabilities. Within the liabilities, the Capital is shown first. After the Liabilities, the Asset is shown.

Under IFRS the treatment is reverse as given below:
• First Assets in the order of liquidity.
• Next is Liability and to start with all the borrowings are taken first.
• Last item will be Equity Capital, which is the net worth of the entities.

Author : CA Shalini Tibe

Challenges for implementation of IFRS

Praveen Bajaj — Fri, 19 Mar 2010 15:28:22 +0000

Key Practical Challenges for implementation of IFRS in India for Banking Industry

No stable Platform: There are many changes / amendment taking place for most of the standards from International Accounting Standard Board there has been no stable platform ready for banks.

Training: All Stakeholders has to be conversant and shall be able to understand and interpret Financials prepared as per IFRS. Training to personnel in an organization is a most crucial.

Judgment: Banks in India are subject to regulatory guidelines provided by regulator i.e. RBI where as under IFRS in most of the areas management judgment is required in framing accounting policy and procedures.

Fair Value: There is extensive use of fair value under IFRS and for assessment of fair value there is need for specialization which is seldom.

Data Capture: There has been modification in reporting system under IFRS and also there has been changes in recognition criteria and an extensive disclosure requirement will require new data and also extraction of historical data for retrospective application will be difficult.

Consolidation of Accounts: IFRS requires data requirement from subsidiary, joint ventures and associates for consolidation purpose at every reporting date. Also policies and procedures have to be consistent throughout the group.

Author : CA Shalini Tibe

Treatment Of Tangible Assets Under IFRS

Praveen Bajaj — Wed, 10 Mar 2010 12:21:28 +0000

Treatment of Property, Plant And Equipment (PPE) under IFRS

First time adoption of IFRS for PPE
An entity can use fair value as deemed cost on First time adoption of IFRS

It has to apply Retrospective application which means recalculate carrying amount of each PPE item according to IFRS since its purchase date including transaction cost, useful life and residual value.

Suggestion
However fair value as deemed cost is more appropriate since there would be practical difficulties for companies to do retrospective application from the date when the asset has been purchased.

Fair value for PPE
Fair value for Land and Buildings is usually determined from market based evidence by appraisal normally undertaken by professionally qualified valuation officers and for other items of PPE their market value is determined by appraisal.

If there is no market-based evidence of fair value because of special nature of asset then it has to be determined on basis of either Income Approach or Depreciated replacement cost approach.

Methods for Subsequent Measurement of PPE
There are 2 methods available for Subsequent measurement of PPE i.e. Revaluation Model and Cost Model.

However most of the LSE listed companies have adopted Cost Model. Generally companies who are in business of Investment property prefer revaluation model.

Suggestion
Cost model is preferable over revaluation model mainly because of the following reasons:

• Once revaluation model is adopted one has to do frequent revaluation as prescribed by IAS 16 which requires expertise of professional valuer which may not be cost effective for companies.

• Also if the property prices changes drastically one has to book the difference in Income Statement resulting in huge volatility which may not be accepted to management of company.

Reclassification
Movement from Cost Model to revaluation model is permitted however vice versa is not permitted which means if Revaluation model once followed cannot move to Cost Model.

Suggestion
Companies should carefully examine the impact before making policy and procedures in respect of the same.

Author: CA Shalini Tibe, IFRS Consultant

Fair Value Accounting in IFRS

Praveen Bajaj — Mon, 28 Dec 2009 15:03:41 +0000

To what extent fair value accounting holds good for valuation in IFRS

Significant percentage of the balance sheet would be at Fair Value compared to current practice of carrying at historical cost under IFRS.

Use of Fair value:

At present Fair Value is limited to impairment of assets, measurement of retirement benefits and mark to market accounting of derivatives where as under IFRS it extend to Held for Trading portfolio, Available for Sale, assets/liabilities designated as fair value through profit and loss and for initial recognition of all financial assets/liabilities will be at fair value.

Current definition:

Currently the definition of fair value stands as “Amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction”

– If quoted in an active market then objective would be the price at which transaction would occur at the balance sheet date in most advantageous market and methods applied would be published price quotations when available, use market quoted rate in valuation techniques or bid price for asset held

– If not quoted in an active market then objective would be transaction price in arm’s length transaction motivated by normal business considerations and method applied would be valuation techniques (recent market transactions, similar instruments, DCF analysis etc.), use commonly used and reliable valuation technique or use market based information

There is lot of doors open for judgement in terms of what will constitute “arm’s length transaction”.

Impact of Fair value:

Fair value accounting brings significant volatility in the income statement.

For instance: All derivative financial instruments have to be recorded at fair value on measurement date, and any change in fair value has to be recorded in income statement thereby bringing volatility in Profit an Loss Account.

Since markets are not liquid for all assets, corporate will have to obtain expert opinion to determine fair value. For e.g. unquoted equity shares have to be recorded at fair value which are now recorded at cost

Different valuation models will be used by various companies which reduce consistency and comparability of financial information to a certain extent.

All these will involve substantial cost for hiring of expertise.

Proposed Definition:

Therefore for bringing all of them under one roof International Accounting Standard Board (IASB) has come out with Exposure draft on “Fair Value Measurement” where fair value has been defined as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (current exit price)”.

So does exit price reflect real fair value? Will exit price will be available for all assets and liabilities to be fair valued on measurement date.

Exit price can be used only when it is supposed that the asset or liability will be sold in a near future; if it is supposed that the asset or liability will remain for long in the company, exit value can’t reflect the right perspective.

In fact, if we want to obtain the value in use of the elements we can’t consider the benefits obtained by selling it, because it won’t be sold.

IASB is expected to come out IFRS on Fair value measurement by third quarter of year 2010.

Author: CA Shalini Tibe, IFRS Consultant

Accounting and Business are Interrelated in IFRS

Praveen Bajaj — Thu, 10 Dec 2009 05:41:57 +0000

There is a feeling that IFRS – rather than business strategy – might actually be driving changes to corporate behavior. In some cases, it may help companies do things better – such as revisit their derivatives strategies – in other cases, it could be changing the way companies work just to get the desired accounting outcome.

IFRS is a principle based model as compared to rule based I GAAP. IFRS requires extensive use of fair valuations for measurement of assets and liabilities. The objective of IFRS is to set the Balance Sheet right, and hence a significant volatility may come in Profit & Loss statement.

There are three principles laid down in IFRS i.e. Substance over form in reality, use of Fair Value and recognizing time value of money.

Changes in IFRS are pervasive and not limited to accounts department. Profit planning and budgeting need to be tuned to incorporate the expected increase in income volatility, arising out of fair valuation system. Staff would need training not only in IFRS accounting but also the changes in the products and processes entailed by the conversion

Key differences in IFRS Vis a Vis INDIAN GAAP

Concept of group – Companies Act treats Indian companies as separate legal entity whereas IFRS promote a group concept

Fair Valuation – IFRS based on Fair value concept and not historical cost

Form and Substance of financial statements

Correction of past errors – Under IFRS these are incorporated in the accounts of the years it pertains to, even if audited and adopted by shareholders whereas under Indian GAAP these are treated as adjustment in the current year

Depreciation on revalued assets needs to be routed through income statement under IFRS – Companies Act disallows such a treatment

Companies Act defines assets by classes which can be depreciated at given rates, whereas as IFRS promotes the concept of components of fixed assets based on their usefulness

Preference shares are classified as debt instrument and not equity effecting profitability and Capital adequacy ratio

No concept of proposed dividend – Declaration of dividend only when approved by shareholders

India being an important emerging economy in the world is yet to adopt the IFRSs. Internationally, in so far as cross-border investments are concerned, a non-IFRS compliant country is perceived as an additional risk factor. Within India also, in recent times, the issue of convergence with IFRSs has been raised time and again at various forums.

One of the risks I feel that IFRS entails is allowing companies to capture unrealized gain in P/L resulting in extra onus on the management to exercise better financial discipline. Because of this companies may end up declaring dividend out of unrealized profits.

Author: CA Shalini Tibe, IFRS Consultant