It is basically search for mineral resources, including minerals, oil, natural gas and similar non-regenerative resources after the entity has obtained legal rights to explore in a specific area, as well as the determination of the technical feasibility and commercial viability of extracting the mineral resource.

Relevant IFRS applicable for Exploration and evaluation of Mineral resources, Oil and Gas Industry

• IFRS 6: Exploration for and Evaluation of Mineral Resources
• IAS 16 – Component accounting for assets
• IAS 36 – Impairments
• IAS 37 – Asset retirement obligations
• IAS 38 – Intangible assets
• IFRS 1 – opening balance sheet

What are the Exploration for and Evaluation Cost?

• Lease acquisition rights
• Technical studies and services
• Seismic costs
• Geologic and geophysical costs
• Exploratory drilling and testing
• Tangible and intangible costs

Transition issues (IFRS1)

Requires retrospective restatement of beginning balances which is subject to very high cost and limited benefits to users

Cash Generating Unit

IFRS 6 defines Cash Generating Unit (CGU) as smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or groups of assets

Impairment of assets is done at the CGU level.  Application of CGU requires judgment. It will involve how management monitor operations, product line, regional areas, decision regarding continuing or disposing operations.

We have already discussed Component accounting in our previous articles.

IFRS 6

Objective - To specify the financial reporting for the exploration for and evaluation of mineral resources

Scope: It applies only to expenditure incurred before exploration and evaluation of mineral resources. It does not apply to companies who are engaged in exploration and evaluation of mineral resources.

Measurement: Exploration for and evaluation assets shall be measured at cost

 It allows Full Cost Method for exploration and evaluation after this the companies are required to follow Successful effort method.

Successful Effort method (SE) v/s Full Cost Method (FC)

Oil and gas sector is only industry where companies are allowed to chose between two extreme different accounting methods.

Exploratory dry holes cost are capitalized in FC method where as in SE it is expensed.

Geologic and geophysical costs are capitalized in FC method where as in SE it is expensed.

Steps to proceed with IFRS 6

• The entity must determine accounting policies specifying which exploration and evaluation expenditures are recognized as assets, and how such assets are to be measured.
• On recognition, exploration and evaluation assets are measured at cost. Subsequently they are measured using either the cost model or the revaluation model. 
• Exploration and evaluation assets are classified as tangible or intangible assets according to their nature.

An exploration and evaluation asset is assessed for impairment when circumstances suggest the carrying amount exceeds the recoverable amount.

Author: Shalini Tibe, IFRS Consultant

Related posts:

1. Delay in defining roadmap of IFRS for banking industry in India
2. IFRS:Why do we need IFRS in India?
3. Comparison of IFRS and Indian Accounting Standards

Exposure Draft (ED) proposes to replace Incurred Loss Model for the assessment of impairment of financial assets measured at amortized cost currently included in IAS 39 with Expected Loss Approach that enables earlier recognition of credit risk.

Incurred Loss Model has been criticized because of following reasons:

 Expected losses are implicit in initial measurement of assets but are not taken into account when determining the Effective Interest rate used for subsequent measurement.

This results in a systematic overstatement of interest revenue in the period before a loss event occurs. In effect, subsequent impairment losses are in part reversals of inappropriate revenue recognition in earlier periods.

If suppose ABC Bank has given loan of Rs.100, 000 @ of 10 percent P.A. for 5 years then following will the schedule for interest repayment:

Under Incurred loss approach 10 percent interest rate includes expected loss factor which is accounted in Profit and Loss account as interest revenue.

Impairment loss is accounted only after a loss trigger is indicated. Thus there is an overstatement of interest revenue in the period before a loss event occurs.  

.

Thus ED has come out with Expected Loss Approach.

Expected Loss Approach (ELA)

•  An entity would have to estimate the expected credit losses over the life of asset on initial measurement of the asset.
•  No gain or loss would be recognized at inception of the asset.
•  The expected credit loss would be incorporated into Effective Interest rate (EIR) and consequently reduces EIR.
• Expected Cash flows (ECF) have to be determined at each measurement date and any gain or loss on subsequent reassessment would have to be recognized immediately in statement of Comprehensive income i.e. Profit and Loss a/c.

The proposed impairment model of ELA generates changes in Effective Interest rate (EIR) to include Expected loss rate in EIR calculation. Mingling of credit risk and credit rate would be difficult and costly to implement and generate significant operational challenges when it comes to practical implementation.

The operational aspects of applying the expected loss approach that requires historical information may not be available with all the entities.

ED proposes that Expected cash flows may be estimated on a Portfolio basis or on Individual basis.

A financial asset can be moved from Portfolio basis to Individual basis or vice versa. Whatever basis chosen, it shall provide the best estimate of Expected cash flow as per ED.

In case of Portfolio basis, Financial assets shall be grouped with similar credit risk characteristics that are indicative of the debtors ability to pay all the contractual amounts when due.

Amount of Expected credit loss would be more reliable when determined on portfolio basis and when based on statistical assessment. Loan portfolio contains a global credit risk exposure that can be estimated with certainty where as for each individual loan granted it will remain unpredictable.

Practically also expected losses can be determined at portfolio level. Because when we are looking at portfolio having similar credit risk characteristics, we can determine that some contractual cash flow will not be received although it may not be known at that point of time which specific asset will not perform.

In contrast entities in respect of individual loan at inception will estimate that it will receive full contractual payment over its term.

Thus International Accounting Standard Board (IASB) shall consider applying Expected loss model on portfolio basis.

IASB plans to issue final standard on amortized cost and impairment in the forth quarter of 2010. However the IFRS implementation date for is January 1, 2013.

Author: CA Shalini Tibe

Related posts:

1. Explanation of IFRS 9
2. Depriciation and Impairment – IFRS and Indian GAAP
3. Treatment Of Tangible Assets Under IFRS

When an item of Property, Plant and Equipment (PPE) is impaired i.e. recoverable amount < carrying amount, carrying amount is reduced to the amount of recoverable amount.

Asset should no more be carried more than their Recoverable amount.

Such a decrease in carrying amount is impairment and is booked in Profit and Loss.

After recognition of an impairment loss, the depreciation charge of the asset shall be adjusted in the future periods to allocate the asset’s revised carrying amount over its remaining useful life.

Example 1:

An entity acquires equipment for Rs.100

Economic life of equipment is 10 years but entity’s policy is to renew such equipment every 5 years i.e. useful life is 5 years

Residual value = 20

Depreciation Plan

Under IFRS there is need to review estimate of residual value at each financial year end where as under Indian GAAP there is no need for an annual review. Below example illustrate depreciation plan when there is change in estimate of residual value.

Suppose in example 1 residual value is estimated in year 4 = 10

Depreciation Plan

Under IFRS there is need to review estimate of useful life at each financial year end where as under Indian GAAP there is no need for an annual review. Below example illustrate depreciation plan when there is change in estimate of useful life.

Suppose now in example 1 the useful life is revised in year 3 as 4 years

Depreciation Plan

Suppose in example 1 depreciation test is performed in year 3 and estimation of recoverable amount at year end is 45

Now if you see in example 1 above the Net book value at year end 3 is 52

Thus Impairment is 52-45 = 7

Related posts:

1. Fixed Assets / Property, Plant & Equipment : Differences between Indian GAAP and IFRS
2. Phase 2 of IFRS 9: Exposure Draft on Amortised cost and Impairment
3. IFRS for exploration of mineral resources and Oil & Gas industry

• CRR hiked by 25 bps; to absorb Rs. 125 billion from the system
• Benchmark Repo and Reverse Repo rates hiked by 25 bps each to 5.25% and 3.75% respectively
• SLR and Bank Rate kept unchanged at 25% and 6%, respectively
• Bank credit growth expectations increased to 20% in fiscal 2011, compared to 17% in fiscal 2010
• Bank deposit growth expectations increased to 18%, marginally higher than 17% reported in fiscal 2010
• GDP forecast hiked to 8.0% with a positive bias for fiscal 2010-11 as compared with expected 7.2-7.5% in fiscal 2010
• Inflation, as mesured by WPI, estimated to moderate to 5.5% by March 2011
• Policy stance is to support “non-disruptive” growth in demand for credit while anchoring inflation expectations; to maintain an interest rate regime consistent with price, output and financial stability
• Banks‟ investments in Non-SLR Bonds of infrastructure companies with residual maturity of more than 7 years allowed to be classified under HTM category
• Provisioning requirement for sub-standard unsecured infrastructure exposures reduced to 15% from 20%
• Scheduled Commercial Banks (SCBs) and Non Bank Finance Companies(NBFCs) with networth more than Rs. 10 billion to migrate to IFRS converged Accounting Standards by April 2013
• Discussion paper on mode of presence of foreign banks by September 2010
• Discussion paper on guidelines for new bank to be placed
• Differential regulatory treatment for Core Investment Companies with asset size of over Rs. 1 billion

 Click here to read our projections of the monetary policy.

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1. First quarterly review of monetary policy 2010-11
2. RBI Monetary Policy 2010
3. RBI likely to raise rates in todays monetary policy review

There is no doubt in that the IFRS results into better accounting quality. There is more detailed disclosure under IFRS as compared to what companies do under Indian GAAP.

Every organization will have to review there business policy & procedures, valuation models, agreements etc. Instead in many organization most of them are carry forward from year to year.

Currently management of companies in India is not serious for convergence to IFRS but rather consider it as a label and not as a commitment to provide investors with higher quality financial information.

A European study on IFRS shows high governance quality companies will be more willing to apply the standard early, even if they have no incentive to do, as opposed to companies with worse governance practices.

But good news is that the regulator, ICAI and other bodies in financial markets have stepped up to respond to investor demands for improved corporate governance, compliance, and transparency by making corporate converging to IFRS by April 2011.

Author name: CA Shalini Tibe

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1. IFRS:Why do we need IFRS in India?
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3. Accounting and Business are Interrelated in IFRS

Following disclosures need to be shown in financial statement:

• A sensitivity analysis of each type of market risk to which the entity is exposed showing how profit or loss and equity is affected.
• The methods and assumption used
• Sensitivities must be reasonably possible
• The changes from the previous period in the methods and assumptions and the reason for changes

 There are three types of market risk that an IFRS 7 addresses:

Currency exchange Risk, Interest Rate Risk & Price Risk

Currency Exchange risk is risk that an entity possess due to fluctuation in fair value or future cash flow because of change in exchange rate.

Generally the Corporate with frequent sale and purchase transactions in foreign denominated currency are more exposed to currency risk. Also Bank Borrowings held in foreign currency is also exposed to this type of risk.

Presentation of Exchange currency risk will require quantitative data about the entity’s exposure to a risk at the reporting date as:

 Disclosure would include as to much will be the impact on Profit or Loss and Equity if Dollar appreciate by X % against Rupee

And

Impact on Profit or Loss and Equity if dollar depreciate by X % against Rupee

This has to be given in respect of all the currencies to which an entity is exposed to.

Interest Rate Risk is risk that an entity possesses due to fluctuation in fair value or future cash flow because of changes in market interest rate. Example: Variable rate Borrowings

Interest rate primarily relate with respect to cash, short term deposits and external borrowings. External borrowings are mostly linked to LIBOR rates while cash and short term borrowings are affected by local markets prevailing in country.

All this has to be continuously tracked by an entity and disclosure has to be made in financial statement.

Price Risk is risk that an entity possesses due to fluctuation in fair value or future cash flow because of changes in market conditions other than Interest rate and Currency Exchange risk. An example is quoted equity investments held

Moreover an organization has to disclose as part of Risk Management policy the method / model adopted to measure those risk with respect to changes in Currency price, Interest rate and price risk changes and underlying assumptions used

All these information are available with organization for internal reporting but matter of attention with respect to management of an organization is that there needs to be drawn thin line which comply requirement of IFRS 7 as well as sensitive information is not disclosed to competitors.

Thus Companies has to be informative and well versed with requirement of IFRS 7.

 Author name: CA Shalini Tibe

Related posts:

1. Comparison of IFRS and Indian Accounting Standards
2. Phase 2 of IFRS 9: Exposure Draft on Amortised cost and Impairment
3. Explanation of IFRS 9

Effective Interest Rate (EIR) is a new concept to the existing Indian GAAP.

TheEffective Interest Rate (EIR) method is a method of calculating the amortized cost of a financial asset or a financial liability and of allocating the interest income or interest expense over the relevant period.

TheEffective Interest Rate (EIR)use in the allocation process is the rate that exactly discounts estimated future cash flows (receipts or payments) to the net carrying amount of the financial instrument through the expected life of this instrument.

EIR calculation is not the same as for Yield to Maturity (YTM). YTM is nothing but the Internal Rate of Return (IRR) of the bond. But Effective Interest Rate (EIR) may also include some non-interest components such as loan origination charges, processing fees as part of the effective rate.

Under IFRS income from Loans and receivables has to be recognized through application of effective interest rate.

An illustration given below gives better clarity for calculation of Effective Interest Rate (EIR).

Given Data:

Calculation of INTERNAL RATE OF RETURN based on above data:

Thus IRR will work out to 3.83%

Thus companies has to maintain Coupon rate as well as EIR which will practically for each transaction will be a major task and will add significantly  load on IT systems.

Author: CA Shalini Tibe, IFRS Consultant

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1. Interest rate Derivatives: Cap
2. Interest Rate Floor
3. Phase 2 of IFRS 9: Exposure Draft on Amortised cost and Impairment

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

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1. Accounting and Business are Interrelated in IFRS
2. Fair Value Accounting in IFRS
3. IFRS: an improvement in accounting quality as well as corporate governance

Market Developments
Global Outlook

• Equity markets sustained their upward move this week, with the S&P500, DJIA and the NASDAQ at new 16-month highs. The US economy is seen ahead of the curve and an interest rate hike may be looming large. The Dollar Index has resumed its uptrend and would probably see 82 levels in the medium term. The problems in Greece and speculation of asset bubble in China would reassert the status of Dollar as the safe haven. The week saw rhetoric from the all quarters on putting pressure on Yuan appreciation while on the Chinese side any further appreciation seems unlikely. It remains to be seen how this political risk unfolds.
• The Euro was the worst-performing G10 currency through the past week of trade and resumed its downfall with its worst week in a while. The single pair dropped 300 pips during the week. The initial buoyant mood which took the currency with 1.3800 levels met with sellers and the currency suffered once again due to continued struggles with the Greek fiscal crisis and questions on the stability of the European Monetary Union. The lack of clarity on the situation and conflicts of opinion within the Euro Leaders is not helping the currency. Whether or not Germany can agree to any plan involving European funds may be of chief importance. Technically the Euro looks weak with up ticks still being sold. It has reached dangerous levels and if 1.3436 is broken simultaneously with indecision persisting on Greece then we would looking at 1.3000 and 1.2700 levels on the downside. Any level above 1.3750 continues to be good levels to sell the currency. Only a break of 1.3800 on a weekly basis would suggest any upside for now.
• The British Pound also fell sharply during the week after rising momentarily to 1.5300 levels. The Cable saw across the board losses with comments from hawkish MPC members and also Andrew Sentence (BOE Member) warning a double dip recession. Jobless claims dropped by 36,000 vis-à-vis expectations of a rise of 6,000. Increase in upside inflation risks is being seen as a risk which might force the central bank to initiate end to quantitative easing. On the other data front, Mortgage approvals declined for a third month in a row, lending standards saw tightening with new loans declining from 48000 from 49000. Restrictive lending continues to a concern blocking growth. Another area of concern is the public net borrowing increasing by 12.4 billion. The overall deficit continues to grow and considering the concerns over troubled counterparts in the Euro-Zone UK could see its AAA rating at risk. Our outlook continues to be negative for the GBP with downside support at 1.4866 and 1.4784. A break of 1.4784 would set us up for a steep fall towards 1.4400 levels in the medium term.
• Key data and events for the US are Chicago Fed National Activity (Monday), Existing home sales (Tuesday). On Wednesday markets would expect durable goods and new home sales. Initial jobless claims would be the highlight on Thursday while the final cut of 4Q gross domestic product and the University of Michigan sentiment index round out the week on Friday. In between Bernanke’s testimony on Wednesday would be the one to watch out for. Euro zone sees Consumer confidence (Monday) while French business confidence is due Tuesday. PMI indices, industrial new orders and the German IFO surveys are due Wednesday. Consumer prices –UK on Tuesday, UK budget release on Wednesday, retail sales on Thursday and business investment is scheduled for Friday.

Domestic Outlook

• As discussed last week inflationary concerns continued to plague the policymakers and once the figure was out crossing 9%, the central bank wasted no time in raising the policy rates by 25 basis points. In the hindsight the timing seemed right with S&P upgrading India’s rating from negative to stable. The interest rate hikes, sustained economic recovery and capital inflows suggests more appreciation for the INR we continue to expect that 45.28 should hold in the near term. A confirmed break of 45.28 would set us up for 45.00 levels. Having said that year end importer buying and continued risk in the Euro –Zone could see the USD strengthening from these levels.

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2. Fortnightly Market Update
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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

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