Impact of IFRS adoption on financial decisions case study of Indian Information Technology Industry : Wipro Ltd.
Expansion of business environment in the 1990s changed the financial set up of India from the conventional bank based borrowings to marked based one. This necessitated companies to address global stakeholders. The regulatory requirement of different countries also necessitated companies to do multiple reporting i.e., one as per home country standard and the other as per the host country standard. To overcome multiple reporting and to address global stakeholders, a uniform system of reporting was felt necessary to facilitate comparisons, which resulted in the establishment of International Accounting Standard Board (IASB) which issues International Financial Reporting Standards (IFRS).
Certain Indian companies having listed in foreign stock exchanges are reporting IFRS voluntarily in their financial statements. The present study tries to understand the impact of this voluntary adoption of IFRS on the financial decision makers through a case analysis of Wipro Ltd. The analysis compared the major financial parameters under IFRS and Indian GAAP as reported by Wipro Ltd for a period of four years from 2009-10 to 2012-13. The results postulate an increase in liquidity ratios; interest coverage ratio; marginal increase in debt equity ratio; and no significant increase in profitability ratios except net profit ratio which rose slightly in the year 2013. Overall the results indicate that the adoption of fair value accounting and strict requirement in adhering to accounting standards have strengthened the financial indicators and provided the decision makers a transparent, true and fair accounting highlighters.
Keywords : Financial markets, Globalization, Financial reporting, Accounting Standards
JEL Classification : E61, F42, G39, M41, O53
Developments in socio--economic fabric in India have changed financial environment of businesses in India from traditional bank based system to market oriented, which paved way for globalization and consequently expansion of financial markets worldwide necessitating companies to raise funds abroad and address investors outside the home country. As a result, companies were required to comply with regulatory requirement of filing financial reports as per home country and global standards, which led to multiple reporting. To overcome multiple reporting and to have a transparent system of reporting which facilitates; comparisons, reduces cost of raising capital, and also fulfills regulatory requirements of different countries, a uniform system of accounting was felt necessary. The establishment of International Financial Reporting Standards (IFRS), a common accounting system and framework, which is perceived as transparent, and fair to local and global investors, and which lead to increased compatibility and comparability among different financial statements across the globe (1). This perception is supported by the findings of Hope, et al. (2), that countries adopt IFRS to improve investor protection, to make capital market more accessible to foreign investors, and to improve comparativeness and comprehensiveness of their financial information.
In the past, companies submitted their annual financials to regulators and banks as a mandatory disclosure, as users of these financial statements were few, with creditors being major stakeholder. Others are investors, employees, customers and management. Employees were happy as long as they were rewarded with good salary/wages/package; employees with their salaries and benefits; customers with quality product at competitive prices. The necessity to read financial statements was never felt by these stakeholders. Even, focus of financial statement was on providing financial information to stockholders and creditors to measure management's performance, and for taxation purpose. However, globalization has given new twist to financial market with a change in focus from traditional stewardship to a broader stakeholder focussed fair valuation. The framework of IFRS also emphasizes that, financial information provided should help stakeholders to make economic and other decisions.
Today, doing business is not only attractive but challenging with higher level of expectations by various stakeholders with different phases of economy and stages of products/services. Business solutions, although look simple have taken a manifold deliverables with shared governances with various aspects, parties, compliances, standards etc. in a multi-country focus of businesses. Investors are always on the lookout for newer investment opportunities in any part of the world, which would add value to them. Expansion of markets internationally has deprived local companies of the home market advantage. Even small and medium industries are exposed to competition, in and around the world. The reputation associated with good financial reporting is more when brands become associated with a company's name (3). As financial statements are the means through which businesses communicate to these various stakeholders, requirement of a uniform system of financial reporting became necessity. Proponents of International Financial Reporting Standards (IFRS) believe that financial statements prepared is to meet common needs of most potential users (4).
The purpose of any financial reporting is essentially to reduce information asymmetry between corporate managers and parties contracting with their firm (Watts, 2001). It is for corporate managers to reduce this information asymmetry by providing transparent financial reports. The IFRS framework (ibid 1989) provides four principal quality features: relevance, reliability, understandability and comparability. Information is said to have relevance only when it helps users in decision making process by evaluating various options. Accounting information needs to be relevant, as accounting report must give user what s/he wants and be useful for decision-making purposes. As users of financial statements do not have access to books and records based on which financial statements are prepared, they depend on companies audited financial statements, which are presumed to be both reliable and relevant (5).
To ensure the reliability and relevance of financial statements, companies in US frequently employ Certified Public Accountant (CPA) firms to validate that the companies' financial information adhered to Generally Accepted
Accounting Principles (GAAP) (6) and so is the case in India with the appointment of certified chartered accountant to audit and certify the financial statements. Any information provided must also have reliability. Information is said to have reliability when it is free from error and bias. Without reliable financial information, decision makers cannot rely on financial statements for making sound economic decisions and indicated reporting improvements in quality of reporting after IFRS implementation to reduce absolute analyst's forecast errors (7). Financial statements must be presented in such a way that there should not be any ambiguity in reporting and give a scope for interpreting it in multiple ways. Comparability of financial statement is another important aspect of IFRS, the main purpose for which uniform accounting standard was initiated. Stakeholders should be able to read financial statement of two different companies and analyze financial performance and position of the company. The International Accounting Standard Board (IASB) (2) works closely with all the stake holders which include investors, analysts, accounting professionals etc of a business to bring in changes to the policies which results in more disclosures.
Users of these financial reports are many, such as investors, creditors, employees, customers, competitors, government, public & so on. Purpose of usage of these reports also differs from person to person. Alexander, et al. (8) divide users of financial reports into Equity investors, Loan Creditors, Employees, Analysts, Suppliers, Customer, Competitors, Government and Public. Shareholders use it to determine the company's financial position to decide whether to invest in the company or not; Creditors to view liquidity position of the company so that they get their payments on time; Employees to know health of the company; Government to monitor the compliances followed and taxation. Companies will be able to initiate new relationships with investors, customers, suppliers and other stakeholders internationally as IFRS provides a globally accepted reporting platform which will ultimately raise reputation and relationship of the corporate and give them a competitive advantage in building their brand.
The introduction of IFRS has fuelled the expectations of users of financial statements on potential benefits of adoption. Studies have confirmed the benefits of IFRS adoption such as higher comparability of financial statements among companies operating in different jurisdictions, lower transaction costs, and access to international capital through cross border listings and greater international investment (9). Many studies done in Europe and Canada who were early adopters of IFRS have confirmed that the adoption has resulted in changes in key accounting parameters and financial ratios of the companies. Though literature finds difference in accounting standards affecting accounting parameters and financial ratios, no study has focused on to find the impact, these differences have on financial decisions. This pertinent case analysis is an attempt to highlight the impact IFRS may have on financial decisions of Wipro Ltd.
IFRS is comprehensive principles based accounting with emphasis on real economic transactions (10). Advocates of IFRS argue that if all companies follow one accounting standards, financial reports of companies would be uniform which facilitates easy comparison. (11) IFRS produces higher quality of financial reporting, enhances the credibility of firm financial statements, and in turn provides lenders with more certainty and information about the ability of firms to timely meet their financial obligations, thus, leading to better borrowing terms (12). A further argument in favor of IFRS is that the provision of more forward-looking information may improve the ability of users to monitor management performance, as the introduction of fair value allows for better assessment of manager ability. Eventually, due to smoother communication between managers, shareholders and other interested parties, agency costs would become lower, which will lead to lower cost of debt financing (13). Barth, et.al., provide evidence that IFRS convey new information to the market which assists investors in making informed decisions, predictions of a firm's future financial performance and signal higher accounting quality through transparency. The improved financial communication helps users in taking decisions as this extended information helps them to understand the dynamics of financial reporting better. Dunne, in his study on implementation of IFRS in UK, Italy and Ireland on whether IFRS enables stakeholders make better informed decisions, reports Italians were very supportive, UK respondents agreed but the Irish were more negative. This was attributed to the negative views of UK and Irish auditors and preparers.
Since profitability is one of the key indicators, showcasing the health of a company, proponents of IFRS claim that adoption of IFRS results in increase in these ratios. Studies by Lantto and Sahlstom (14) examined the impact of IFRS adoption on key financial ratios of Finnish companies. The results showed that, IFRS changes the magnitude of accounting ratios due to the adoption of fair value accounting and stricter requirement on certain accounting issues. The results indicated increase in profitability and gearing ratios and decrease in PE, equity and quick ratios. The study by Punda (15), on UK companies found that, though UK GAAP and IFRS are very much similar in many aspects, still there was sizeable difference in financial ratios after conversion to IFRS, with respect to profitability and liquidity ratios.
Hung and Subramanyam (16) investigated the effects of IFRS on Financial statements of German Companies during the period 1998-2002. The study found increase in total assets and book value of equity under IFRS and also variability of book value and income. Henry, et. al., (17) examined the reconciliation between US GAAP and IFRS of EU cross-listed firms from 2004 to 2006. Their findings indicate differences in net income and shareholders equity between industries. Firms reported higher net income and lower shareholder equity under IFRS than US GAAP. Dunne, et.al., state that the main reason for European countries to adopt IFRS is due to its potential benefits: improvements of investor protection, capital market accessibility to foreign investors, comparability and quality of financial statements.
Rahmonova (18) found substantial difference between financial ratios for companies reporting under IFRS versus US GAAP. These differences increased the need of investors and other financial statement users to understand the changes that results from the new set of standards to make well informed and sound financial decisions. According to Pricewaterhouse Coopers (19), "Executives can expect that IFRS conversion could affect business fundamentals, such as, communications with key stakeholders, operations and infrastructure, tax and human capital strategies". Even it is expected that, some rules and guidelines concerning assets and liabilities, revenues and expenses, equities are going to change according to IFRS.
As few of the Indian companies listed in European Union and New York stock exchanges have adopted IFRS voluntarily as early as 2007 (without waiting for Government announcement). The present case study analysis is an attempt to explores the impact of this voluntary adoption of International Financial Reporting Standards on financial decisions. The study compares major financial parameters under IFRS and Indian GAAP as reported by Wipro for a period of four years from 2009-10 to 2012-13, and its possible impact in terms of benefits / drawbacks to all the external/internal stakeholders.
The study analyses financial statements of Wipro, both balance sheet and income statement from 2009-10 to 2012-13 (four years). Financial ratios, both under IFRS and Indian GAAP are the focal areas of analysis. Further, the study draws the differences in financial ratios under both standards and builds on the inherent information to financial decision makers. Financial ratios provide a benchmark for comparability of firms to review their growth in relation to previous years or with competing companies or against industry standard. Thus, nine financial ratios have been identified and are grouped into four categories i.e., Liquidity, Debt, Equity and Profitability (*). (see Exhibit)
Wipro started reporting under IFRS from 2009-2010, with transition date of 01.04.2008. The company reports its financials both under Indian GAAP and IFRS. Data has been extracted from both Indian GAAP and IFRS as reported by Wipro to calculate, compare, and for analysis.
Wipro Ltd (Wipro) is one of the largest IT services companies of India. Established in 1945 as an edible oil company, it later forayed into IT business. Wipro is also into other businesses such as consumer care, lighting and infrastructure engineering. The company is predominantly equity financed, with its total loans and borrowings amounting only to 18 per cent of capital mix as on March 31, 2013. The market capitalization of the company as on March 31, 2013 is $1075 bn. Over the last six years the growth of revenue and profit are noticed at a CAGR of 20 per cent and 14 per cent respectively. The company's operations are found in 54 countries with an intellectual strength of 142,000+ across services/countries. Primarily, the companies stocks are listed at National Stock Exchange and Bombay Stock Exchange. The company's American Depositary Receipts (ADR) representing equity shares are listed in New York Stock Exchange.
First time adopters of International Financial Reporting Standards are required to explain the reasons for difference in figures from Indian GAAP to IFRS with a reconciliation of Equity and Profit and Loss Account as on the date of transition. This explanation along with the notes to the consolidated financial statements has been used to interpret the reasons for the difference in ratios calculated.
A. Liquidity Ratios
* Current Ratio : Current Assets / Current Liabilities
* Quick Ratio : Current Assets - (Inventory + Prepaid Expenses) / Current Liabilities
* Debt Equity Ratio : Total Liabilities / Stockholders Equity
* Interest Coverage Ratio : (*) EBIT / Interest Expense
* Proprietary Ratio : Stockholders Equity / (Total Assets Intangibles)
B. Profitability Ratios
* Current Ratio : Current Assets / Current Liabilities
* Net Profit Ratio : Net Profit after tax / Net Sales
* Return on Equity : Net Income / Stockholders Equity
* Fixed Assets Turnover Ratio : Net Sales / Average Total Assets
* Return on Capital Employed : (*) EBIT/(Total Assets - Current Liabilities)
(*) Earnings before interest and tax
The percentage difference between the ratios under IFRS and Indian GAAP is calculated by: Percentage Difference = (Ratio under IFRS - Ratio under Indian GAAP) * 100 Ratio under Indian GAAP)
Liquidity ratios are a measure of company's ability to meet short term financial obligations and it reflects on the margin of safety management maintains to overcome any adverse situations. Table 1 postulates that, both the current and quick ratios have increased significantly from a negative 15 per cent difference in 2010 to a positive 17 per cent in 2013. This gives a positive signal to lenders/bankers as they look into the solvency of a company before financing. A good liquidity position helps managers not only to address fixed obligations of company but also helps them in taking decisions with regard to declaration of dividend, expansion, diversification etc. From shareholder perspective if liabilities are less, it is good news to them as the company is adding value to them in form of financial assets.
A reduced current liabilities and strengthened current asset is the reason for this significant improvement in liquidity ratios. Where Indian GAAP requires provision for dividend to be made before it is approved by shareholders, IFRS requires approval before payment of dividend. This reduces provision for liability to a considerable extent. IFRS recognizes lease advance and rentals as current assets and available for sale financial assets are measured at fair value at reporting date. Indian GAAP treats lease advance and rentals in PPE and available for sale financial assets are measured at cost or market value whichever is lower. Under IFRS Available for sale financial assets and liabilities are measured at fair value whereas in IGAAP short term investments are measured at lower of cost or fair value. This reporting difference has boosted current asset in IFRS and resulted in a better liquidity position.
Debt Equity ratio is a long term solvency ratio which indicate relation between portion of assets provided by stockholders and portion of assets financed by creditors. A high debt equity ratio means company is at risk, as it has to earn not only to reward the stockholders but also to fulfill the commitment to lenders.
Table 2 shows that difference in ratio has decreased marginally from a negative 13.34 per cent in 2010 to -14.74 per cent in 2013. Low debt symbolizes low risk and gives confidence to the lenders that their debt would be repaid in time. Low debt also means that earnings of the company are not spent on repaying interest but to reward shareholders for the risk undertaken. An average debt equity ratio for four years hovering around 0.57 under IFRS as against 0.66 under Indian GAAP reflects financial health and managerial efficiency of the company to external stakeholders.
Reduction in debt equity ratios is on account of increase in equity due to recording of Minority Interest within Equity; accelerated amortization of stock compensation expense in the initial years under IFRS; recognizing changes in the fair value of available for sale financial investments at reporting date directly in equity which increased the denominator and decrease in liability and increase in equity due to recognition of dividend after shareholder approval.
Interest Coverage is a financial ratio which indicates the company's ability to pay interest charges on its debt. The coverage aspect of ratio indicates the number of times interest could be paid from available earnings, thereby providing a sense of safety margin a company has, for paying its interest for any period. Table 2 shows difference in interest coverage ratio between Indian GAAP and IFRS as very volatile ranging from a negative 6.28 per cent in 2010 to a positive 7.08 per cent in 2013.
Low interest coverage in IFRS and a greater difference in ratio reflected in the years 2010 (-6.28) and 2011(-58.68) are due to exchange fluctuation of foreign currency borrowings which is shown as deduction to other income in the profit and loss account in Indian GAAP, whereas in IFRS it is shown as an interest expense. Because of this, interest coverage under IFRS in the years 2010 and 2011 were very low (especially in 2011) compared to Indian GAAP. But following the companies bill of 2011 which was initiated to align Indian GAAP with IFRS, the exchange fluctuation on foreign currency borrowings was also shown as an interest expense in Indian GAAP from 2012 onwards, instead of adjusting with other income. As a result of which the difference between ratios has narrowed from 2012 onwards and has strengthened under IFRS in 2013.
By including the risk on foreign currency borrowings along with fixed obligations, IFRS strengthens the internal control systems of the company which also reflect on the Management's perspective. As the ability to pay interest on borrowings is a tool for testing the solvency of the company, a higher ratio portrays a positive signal to the lenders and margin of safety to the shareholders.
Proprietary ratio indicates relationship between owners' funds and total assets. It reflects extent to which owners funds are invested in different types of assets and financial strength of the company. Higher ratio indicates long term solvency position of the company and lower ratio indicates greater risk to the creditors.
As per Table 3, the percentage difference has been around 6 per cent in almost all the years. A high proprietary ratio under IFRS indicates the soundness of the capital structure, healthier long term solvency of the company, a good return to the shareholders and a greater security for creditors.
The increase in equity is on account of presentation of minority interest within equity; changes in the fair valuation of available for sale investments under equity on reporting date and accelerated amortization of stock compensation in the initial years. Increased intangibles under IFRS reduce the denominator thereby increasing the equity ratio. Including minority interest increases the shareholders equity and the ratio.
Net profit ratio measures the efficiency of a company. It reflects on companies pricing policy, cost structure and production efficiency. A low profit indicates low margin of safety for stakeholders as decline in sales in subsequent years would erode profits.
Net profit (Table 4) remains more or less the same under both Indian GAAP and IFRS except in the year 2013 where the percentage difference between Indian GAAP and IFRS is 8.46 per cent. This is due to demerger and discontinuation of operations by of certain subsidiary companies, by which assets & liabilities of these companies are adjusted against reserves of Wipro as on March 31, 2012. However, IFRS continues to show the profits of the discontinued (demerged) operations separately in its income statement in 2013, which has resulted in the difference of 8.46 per cent in the ratios. With profits of continued and discontinued (demerged) operations separately in the income statement, a transparent communication is sent to all the stakeholders reading the report to take appropriate decisions. High and consistent profitability of the company is looked into by investors to assess the risk of investing, creditors for determining repaying capacity of debts and Governments to compute taxes.
Return on Equity is the measure of financial efficiency of a company. Higher values indicate efficiency of the company in generating income from investment to its stockholders. Table 4 shows minor difference in ratios under IFRS and Indian GAAP which is on account of minority interest of company recognized within equity in IFRS and is presented separately from equity in Indian GAAP. Increase in equity is also on account of fair value measurement of available for sale investments at each reporting date, whereby the changes in the fair value of these investments are recognized under equity. Liability for dividend declared after the reporting period is recognized in retained earnings under IGAAP is derecognized under IFRS, as under IFRS dividend is to be recorded only after approval. This presentation difference also increases equity under IFRS. This presentation difference between IFRS and Indian GAAP has resulted in increase in equity under IFRS, resulting in low return to stockholders. But by reporting minority interest within equity, IFRS facilitates stakeholders, investors and lenders to identify their share on returns of the company, after taking into account stake of minority interest.
Fixed asset turnover ratio measures sales generated by the company out of investment made in fixed assets. Higher ratio is a good indicator as it signifies greater level of usage of fixed assets. Negative and low difference found is on account of leases of land which are classified as operating leases in IFRS and lease advance and rentals are recognized as income in profit and loss account, whereas in Indian GAAP, these are treated as finance lease and are taken to Property, Plant & Equipment (PPE). The treatment of lease accounting not only affects fixed asset turnover ratio but also ratios such as return on equity and EBITDA etc. and also changes the user's decision making about their investment. There is a negative difference as regards fixed assets turnover ratio as under IFRS advances paid for acquisition of property, plant and equipment outstanding at reporting date are disclosed under Capital work in progress. Under IGAAP, these advances are shown under Long term loans and advances. This reporting difference and the fair valuation increase the denominator and reduce the ratio under IFRS.
Return on capital employed measures the efficiency with which investments made by stakeholders and creditors are used. By comparing net income to sum of a company's debt and equity capital, investors get a picture of how leverage impacts company's profitability. Analysts consider ROCE as a measurement of comprehensive profitability indicator because it gauges management's ability to generate earnings from a company's total pool of capital.
The difference in ROCE shows a gradual decline under IFRS from a positive 10.19 in 2010 to a--8.40 in 2013. As regards return on capital employed a low current liability on account of not providing for dividend increases the denominator and eventually reduces the ratio. Denominator of the ratio is also increased due to fair value accounting; recognizing customer related intangibles and balance sheet approach to recognize deferred tax. This reporting difference resulted in reduced return on capital employed under IFRS.
This study supports the literature on the impact of adoption of IFRS on accounting figures and key financial ratios of Wipro Ltd used by investors, creditors, analysts etc. Results indicate considerable increase in liquidity ratios, equity ratio and interest coverage ratio, marginal increase in debt equity ratio and no significant increase in any of the profitability ratios. The major reasons for difference in ratios could be attributed to principle based IFRS standard which requires fair value accounting, difference in accounting for leases, balance sheet approach to deferred taxes, and timing of providing provision for proposed dividend.
As users of financial statements are not experts in reading and taking decisions based on reports, explanation provided by way of notes to accounts under IFRS makes it easier for even a novice to understand the reports. As IFRS adoption requires providing more extensive information; transparency, quality and control systems of companies get strengthened. Thus IFRS not only impact the accounting figures but also brings in changes within the organization by strengthening their internal systems and processes. Overall the results indicate that adoption of fair value accounting and strict requirement in adhering to accounting standards have strengthened the financial figures and provided decision makers a transparent, true and fair accounting picture. Though the initial cost involved in transition is high, companies need to adopt IFRS to participate in a globalised financial market, to enable investors and other users of financial statements.
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VIDYA CHANDRASEKAR, M. Com., Ph.D.
Department of Commerce
email : Vidya15592@gmail.com
Professor D.N.S. KUMAR, Ph. D.
Professor of Finance & Associate Director
Centre for Research - Projects
email : email@example.com
Christ University, Hosur Road
Bengaluru - 560029, INDIA
TABLE 1 LIQUIDITY RATIOS Ratios IGAAP 2010 2011 2012 2013 2010 Current Ratio 2.26 2.27 1.99 1.82 1.90 Quick Ratio 2.16 2.16 1.92 1.80 1.83 Ratios IFRS Difference in % 2011 2012 2013 2010 2011 2012 2013 Current Ratio 2.31 2.32 2.12 -15.61 1.86 16.52 16.96 Quick Ratio 2.21 2.23 2.10 -15.24 2.49 16.60 16.98 TABLE 2 DEBT RATIOS Ratios IGAAP 2010 2011 2012 2013 2010 Debt Equity Ratio 0.78 0.63 0.60 0.64 0.68 Interest coverage Ratio 45.72 81.35 21.30 28.19 42.85 Ratios IFRS Difference in % 2011 2012 2013 2010 2011 Debt Equity Ratio 0.55 0.52 0.54 -13.34 -13.76 Interest coverage Ratio 33.61 20.98 30.19 -6.28 -58.68 Ratios 2012 2013 Debt Equity Ratio -12.16 -14.74 Interest coverage Ratio -1.51 -6.28 TABLE 3 EQUITY RATIOS Ratios IGAAP 2010 2011 2012 2013 2010 Proprietary Ratio 0.67 0.72 0.74 0.70 0.72 Ratios IFRS Difference in % 2011 2012 2013 2010 2011 2012 2013 Proprietary Ratio 0.77 0.79 0.74 7.21 6.58 5.63 6.97 TABLE 4 PROFITABILITY RATIOS Ratios IGAAP IFRS 2010 2011 2012 2013 2010 2011 2012 2013 Net Profit Ratio 0.17 0.17 0.15 0.16 0.17 0.17 0.15 0.18 Return on Equity 0.25 0.23 0.21 0.23 0.23 0.22 0.20 0.22 Fixed Asset T/O 5.09 5.62 6.51 6.96 5.1 5.72 6.52 6.83 ROCE 0.23 0.23 0.25 0.30 0.25 0.24 0.23 0.28 Ratios Difference In % 2010 2011 2012 2013 Net Profit Ratio -0.36 0.70 -0.13 8.46 Return on Equity -6.80 -5.26 -5.56 -6.69 Fixed Asset T/O 0.10 1.80 0.12 -1.81 ROCE 10.19 5.79 -6.49 -8.40
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|Author:||Chandrasekar, Vidya; Kumar, D.N.S.|
|Publication:||Journal of Financial Management & Analysis|
|Date:||Jul 1, 2016|
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