IFRS- Impact on Country's GDP

IFRS (International Financial Reporting Standards) is not just a corporate subject but something which is of national interest. As the world turns into a ‘Global village’ it is difficult for a country to stand isolated with separate set of standards or principles (be it accounting or foreign investment policies etc.). Especially a developing country like India has to act according to the likes of super powers like Europe or USA till it sees those halcyon days.

Before jumping into the study of the impact on GDP, let us recollect once what is GDP and how is it measured so as to appreciate the forthcoming paragraphs. GDP in simple terms is defined to be the sum of the market values of all goods and services produced within a country. But the measurement is done using three approaches namely, product approach (most commonly used), producer’s income approach and Expenditure approach. Under product approach GDP can be computed by gathering data on Sales and inventories of all companies in India as per their records or by multiplying their outputs with market value and reducing the same with cost of intermediate materials used to arrive at GDP. This actually gives the Gross Value addition by each company because otherwise there will be double counting wherein the cost of intermediate products would be included as final output of the ancillary as well as the Original Equipment Manufacturer (OEM) along the supply chain. Given the time constraint the simple way is to go basis the sales recorded in books rather than applying the market value to the output. Income approach calculates GDP as sum total income of all individuals and producers such as corporate profits, wages, interest and other investment income, farmer’s income and nonfarm unincorporated business income. Under expenditure approach GDP is an embodiment of private consumption, Government spending, Investment and Net Exports (after deducting imports).

From a macro perspective, the impact of IFRS Adoption will certainly be on the country’s GDP (Gross Domestic Product). Let us examine some of these impacts of IFRS on GDP with the background from the preceding paragraph. The belief is all the points discussed below may cumulatively affect the GDP.                                                                                   

Need for IFRS amidst changing neighbours:

Indian GDP should be measured on a global standard for justifiable comparison. For this to happen, India has to switch over to IFRS. The reason being that fair value may differ from one country to other. This can happen for e.g. considering a scenario where India and China export the same commodity to USA. As per the upcoming standards on Fair valuation (Ind AS 113 deals with how to determine fair value though this standard is yet to get notified by MCA) fair value should by default be determined based on the ‘Principal market’ which is the market with the greatest volume and level of activity for the asset or liability. Assuming that based on facts, USA is a principal market for both the countries in our example. The possibility is that if China has adopted IFRS, it may account all transactions based on Fair value in USA for the commodity, whereas India (if not adopted IFRS) will account the revenue based on actual transaction value under current IGAAP. Thus despite same trading conditions, the revenue on such exports getting accounted differently in these two countries will not justify the comparison of GDP among these two nations

Artificially priced Transactions:

Artificial pricing is increasingly getting popular nowadays which creates transfer pricing disputes with taxman. IFRS can go a long way reducing the transfer pricing disputes provided the taxman aligns to the national interest. The simple reason is that both employ fair values for their valuation. Consider the case of an intra group export transaction which is artificially low priced. It will now have to get valued at Arm’s Length price which may be on the higher side and accounted accordingly. The result is higher Sales value scaling up the GDP of the nation. Beware that in a domestic sale transaction the scenario can be a little extensive. Assume an Indian Company X selling a product with fair value of Rs.100 to Company Y which is its Indian subsidiary for just Rs.60. The deficit of Rs.40 is an abnormal discount not considered for fair valuation purpose and expensed off. The effect on GDP can be understood in the form of an example below:

One very crucial point arising from the above table is with regard to accounting for purchases. While Co.Y will still account for the inventory at the actual invoice value thanks to Ind AS-2 which retains the recording of inventory at actual purchase price, the sales value accounted by Co. X will change from actual transaction value to Fair value by virtue of Ind AS-18 on Revenue recognition. Of course, if we assume the other way i.e. the fair value is lesser than the actual value then the impact on GDP might be negative.

Impact on Corporate profits: Income Approach

One of the ingredients of this approach is the corporate surplus. Most of us are aware in general that to begin with IFRS is applicable only to incorporate businesses. The impact of IFRS on corporate profits is already appreciated widely. Thus GDP will also get impacted. An apt instance is the enforcement of mandatory Consolidation by all entities with subsidiaries across the board which will unearth all undisclosed profits from low tax regions and raise the tax incidence. If Government is able to leverage the situation with high tax revenues, it can translate it to increase in GDP with productive investments. It deserves a mention that we have a unique scenario ahead where Revenues alone will get accounted at fair values and not purchases or expenses which are at actuals. Thus, it will be difficult to have consistent margins and profit ratios year after year. Though there are other components in income approach, it is unlikely that they will get impacted due to Ind AS.

Impact using Expenditure approach:

Gross investment in fixed asset is a component of the Expenditure approach. Consider the case of purchase of machinery by a Company which will be accounted as a fixed asset in its books. Under IGAAP this asset would have been measured at its actual purchase price. But under IFRS (Ind AS 16 on Property Plant and Equipment), the recognition will be done at the Cash price equivalent of the asset i.e. any deferred credit terms will be removed from the actual cost, thus making the purchase price accounted in books lesser. Though a portion of this purchase price is deemed to be a finance cost, it does not enter the computation of GDP. From the view point of expenditures, the GDP may go down as the gross investment value as per records is less. (For the reader’s information, financial investments are considered as savings and not Expenditure.)

Having said this we now get introduced to a novel concept called ‘dismantling expenditure’. An initial estimate of expenditure expected to be incurred to dismantle the fixed asset at the expiry of a specified duration as per certain agreement or regulation is added to the purchase cost of the assets at the inception itself. Also there are instances where major spare parts and overhaul costs are required to be capitalised. These will inflate the GDP.

Transfer of assets from customer is a new scenario that is reckoned under Ind AS unlike IGAAP. Auto industry is an apt example for such situations wherein import of jigs, moulds or fixtures from customer abroad for use in production on their behalf is common. These tools or assets could be re-exported in a year or couple. Ind AS seeks to impose accounting for such assets in the transferee books provided they meet the prescribed asset recognition criteria and give credit to Revenue account. This is a peculiar case because the asset would be considered as a fresh gross investment within India thereby increasing the GDP (if expenditure approach was followed). This would not have been the case earlier.

Smoothening of GDP: (Service Sector)

A Rupee earned today is more valuable than a two earned a couple of years later. Our Service sector is a massive contributor towards GDP of about close to 60% of the total. Earlier AS-9 on Revenue Recognition gave an option to account for continuous service contracts using either Completed service method or percentage of completion method. Rest assured that the former would have been favoured by most in the industry given that no assumptions such as stage of completion or more calculations are involved and less time. But Ind AS gives acceleration to Government revenues by requiring that only Percentage of Completion method has to be followed. This will also even out the contribution of service sector in the country’s GDP.

On the whole there are instances which might favour Government due to high tax revenue possibilities and not the Corporate and vice versa as well. Only statistics can assign weights to the instances discussed above so as to determine the direction of net impact on GDP. But is IFRS in India a reality or a mirage? Let us wait and see.