UNDERSTANDING THE US GAAP WITH INDIAN GAAP

With the globalization  and advancement of India, Indian accountant professionals(IAP) are not only required to follow the India AS but also required to follow the US GAAP, as many MNC are doing the accounting job from India and  IAP are not require to prepare the financials for Indian company but also financials for other countries also. Its not only financials, but also various legal & tax compliances for other countries The IAP are doing the same either onsite or offsite.

In the article given below, we try to understand few concepts of US GAAP.

Some of these major differences between US GAAP and Indian GAAP which  give rise to differences in profit are highlighted hereunder:

1.      Underlying assumptions: Under Indian GAAP, Financial statements are prepared in accordance with the principle of conservatism which basically means “Anticipate no profits and provide for all possible losses”. Under US GAAP conservatism is not considered, if it leads to deliberate and consistent understatements.

2.      Prudence vs. rules : The Institute of Chartered Accountants of India (ICAI)  has been structuring Accounting Standards based on the International Accounting Standards ( IAS) , which employ concepts and `prudence' as the principle in contrast to the US GAAP, which are  "rule oriented", detailed and complex. It is quite easy for the US accountants to handle issues that fall within the rules, while the International Accounting Standards provide a general framework of accounting standards, which emphasise "substance over form" for accounting. These rules are less descriptive and their application is based on prudence. US GAAP has thus issued several Industry specific GAAP , like SFAS 51 ( Cable TV),  SFAS 50 (Record and Music Industry) , SFAS 53 ( Motion Picture Industry) etc.

3.      Format/ Presentation of financial statements: Under Indian GAAP, financial statements are prepared in accordance with the presentation requirements of Schedule VI to the Companies Act, 1956. On the other hand , financial statements prepared as per US GAAP are not required to be prepared under any specific format as long as they comply with the disclosure requirements of US  GAAP. Financial statements to be filed with SEC include

4.      Consolidation of subsidiary companies: Under Indian GAAP (AS 21), Consolidation of Accounts of subsidiary companies  is not mandatory. AS 21 is mandatory if an enterprise presents consolidated financial statements. In other words, the accounting standard does not mandate an enterprise to present consolidated financial statements but, if the enterprise presents consolidated financial statements for complying with the requirements of any statute or otherwise, it should prepare and present consolidated financial statements in accordance with AS 21.Thus, the   financial income of any  company taken in isolation neither reveals the quantum of business between the group companies nor does it reveal the true picture of the Group . Savvy promoters   hive off their loss making divisions into separate subsidiaries, so that financial statement of their Flagship Company looks attractive .Under US GAAP (SFAS  94),Consolidation of results of Subsidiary Companies  is mandatory , hence eliminating  material, inter company transaction  and giving a true picture of the operations and Profitability of the various majority owned Business of the Group.

5.      Cash flow statement: Under Indian GAAP (AS 3) , inclusion of Cash Flow statement in financial statements is mandatory only for  companies whose share are listed on recognized stock exchanges and Certain enterprises  whose turnover for the accounting period exceeds Rs. 50 crore. Thus , unlisted companies escape the burden of providing  cash flow statements as part of their financial statements. On the other hand, US GAAP (SFAS 95) mandates furnishing of cash flow statements for 3  years – current year and 2  immediate preceding years irrespective of whether the company is listed or not .

6.      Investments: Under Indian GAAP (AS 13), Investments are classified as Current and Long term. These are to be further classified Government or Trust securities ,Shares, debentures or bonds Investment properties Others-specifying nature. Investments classified as current investments are to  be carried in the financial statements at the lower of cost and fair value determined either on an individual investment basis or by category of investment, but not on an overall (or global) basis. Investments classified as long term investments are  carried in the financial statements at cost. However, provision for diminution is to be  made to recognise a decline, other than temporary, in the value of the investments, such reduction being determined and made for each investment individually.   Under US GAAP ( SFAS 115) ,  Investments are required to be segregated in 3 categories i.e. held to Maturity Security ( Primarily Debt Security) , Trading Security and Available for sales Security and should be further segregated as Current or Non current on Individual basis.  Debt securities that the enterprise has the positive intent and ability to hold to maturity are classified as held-to-maturity securities and reported at amortized cost. Debt and equity securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities and reported at fair value, with unrealised gains and losses included in earnings. All Other securities  are classified as available-for-sale securities and reported at fair value, with unrealised gains and losses excluded from earnings and reported in a separate component of shareholders' equity

7.      Depreciation: Under the Indian GAAP, depreciation is provided based on rates prescribed by the Companies Act, 1956.  Higher depreciation provision based on estimated useful life of the assets is permitted, but must be disclosed in Notes to Accounts.( Guidance note no 49) . Depreciation cannot be provided at a rate lower than prescribed in any circumstance. Similarly , there is no compulsion to provide depreciation at a higher rate, even if the actual wear and tear of the equipments is higher than the rates provided in Companies Act. Thus , an Indian Company can get away with providing with lesser depreciation , if the same is in compliance to Companies Act 1956. Contrary to this, under the US GAAP , depreciation has to be provided over the estimated useful life of the asset, thus making the Accounting more realistic and providing sufficient funds for replacement when the asset becomes obsolete and fully worn out.

8.      Foreign currency transactions:  Under Indian GAAP(AS11) Forex transactions ( Monetary items ) are recorded at the rate prevalent on the transaction date .Year end foreign currency assets and liabilities ( Non Monetary Items) are re-stated at the closing exchange rates. Exchange rate differences arising on payments or realizations and restatements at closing exchange rates are treated as Profit /loss in  the income statement.   Exchange fluctuations on liabilities incurred for fixed assets can be capitalized. Under US GAAP (SFAS 52), Gains and losses on foreign currency transactions are generally included in determining net income for the period in which exchange rates change unless the transaction hedges a foreign currency commitment or a net investment in a foreign entity . Capitalization of exchange fluctuation arising from foreign liabilities incurred for acquiring fixed assets does not exist. Translation adjustments are not included in determining net income for the period but are disclosed and accumulated in a separate component of consolidated equity until sale or until complete or substantially complete liquidation of the net investment in the foreign entity takes place . US GAAP also permits use of Average monthly Exchange rate for Translation of Revenue, expenses and Cash flow items, whereas under Indian GAAP, the closing exchange rate for the Transaction date is to be taken for translation purposes.

9.      Expenditure during Construction Period: As per the Indian GAAP (Guidance note on ‘Treatment of expenditure during construction period' ) , all incidental expenditure on Construction of Assets during Project stage  are accumulated and allocated to the cost of asset on completion of the project. Contrary to this, under the US GAAP (SFAS 7) , such  expenditure are  divided into two heads – direct and indirect. While, Direct expenditure is accumulated and allocated to the cost of asset, indirect expenditure are charged to revenue.

10.   Research and Development expenditure: Indian GAAP ( AS 8)   requires research and development expenditure to be charged to profit and loss account, except equipment and machinery which are capitalized and depreciated. Under US GAAP ( SFAS 2)  , all R&D costs are expenses except intangible assets purchased from others and Tangible assets that have alternative future uses which are capitalised and depreciated or amortised as R&D Expense. Under US GAAP, R&D expenditure incurred on software development are expensed until technical feasibility is established ( SOP 81.1) . R&D Cost and software development cost incurred under contractual arrangement are treated as cost of revenue.  Please note that AS- 8 is no more applicable and in place of that AS-29 is applicable.

11.   Revaluation reserve : Under Indian GAAP, if an enterprise needs  to revalue its asset due to increase in cost of replacement and provide higher charge to provide for such increased cost of replacement, then the Asset can be revalued upward and the unrealised gain on such revaluation can be credited to Revaluation Reserve ( Guidance note no 57). The incremental depreciation arising out of  higher book  value may be adjusted against the Revaluation Reserve by transfer to P&L Account.  However for window dressing some promoters misutilise this facility to hoodwink  the shareholders on many occasions. US GAAP does not allow revaluing upward property, plant and equipment or investment.

12.   Long term Debts: Under US GAAP , the current portion of long term debt is classified as current liability, whereas under the Indian GAAP, there is no such requirement and hence the interest accrued on such long term debt in not taken as current liability.

13.   Extraordinary items, prior period items and changes in accounting policies: Under  Indian GAAP( AS 5) , extraordinary items, prior period items and changes in accounting policies are disclosed without netting off for tax effects . Under US GAAP (SFAS 16) adjustments for tax effects are required to be made while reporting the Prior period Items.

14.     Goodwill: Under the Indian GAAP goodwill is capitalized and charged to earnings over 5 to 10 years period. Under US GAAP ( SFAS 142) ,  Goodwill and intangible assets that have indefinite useful lives are not  amortized ,but they are  tested at least annually for impairment using a two-step process that begins with an estimation of the fair value of a reporting unit. The first step is a screen for potential impairment, and the second step measures the amount of impairment, if any. However, if certain criteria are met, the requirement to test goodwill for impairment annually can be satisfied without a remeasurement of the fair value of a reporting unit.

15.     Capital issue expenses: Under the US GAAP, capital issue expenses are required to be written off when incurred against proceeds of capitals, whereas under Indian GAAP , capital issue expense can be amortized or written off against reserves.

16.     Proposed dividend: Under Indian GAAP , dividends declared are accounted for in the year to  which they relate. For example, if dividend for the FY 1999-2000 is declared in Sep 2000 , then the corresponding charge is made in  2000-2001 as below the line item . Contrary to this , under US GAAP dividends are reduced from the reserves in the year they are declared by the Board. Hence in this case under US GAAP , it will be charged  Profit and loss account of 2000-2001 above the line.

17.     Investments in Associated companies: Under the Indian GAAP( AS 23) ,  investment in associate companies is initially recorded at Cost using the Equity method whereby the investment is initially recorded at cost, identifying any goodwill/capital reserve arising at the time of acquisition. The carrying amount of the investment is adjusted thereafter for the post acquisition change in the investor’s share of net assets of the investee. The consolidated statement of profit and loss reflects the investor’s share of the results of operations of the investee.are carried at cost . Under US GAAP ( SFAS 115)  Investments in Associates are accounted under equity method in Group accounts but would be held at cost in the Investor’s own account.

18. Preoperative expenses: Under Indian GAAP, (Guidance Note 34 - Treatment of Expenditure during Construction Period), direct Revenue expenditure during construction period like Preliminary  Expenses, Project related expenditure are allowed to be Capitalised.  Further , Indirect revenue expenditure incidental and related to Construction are also permitted to be capitalised. Other Indirect revenue expenditure not related to construction, but since they are incurred during Construction period are treated as deferred revenue expenditure and classified as Miscellaneous Expenditure in Balance Sheet and written off over a period of 3 to 5 years. Under US GAAP ( SFAS 7)  , the concept of preoperative expenses itself doesn’t exist. SOP 98.5 also madates that all Start up Costs should be expensed. The enterprise has to prepare its balance sheet and Profit and Loss Account as if it were a normal running organization.  Expenses have to be charged to revenue and Assets are Capitalised as a normal organization.  The additional disclosure include reporting of cash flow, cumulative revenues and Expenses since inception. Upon commencement of normal operations, notes to Statement should disclose that the Company was but is no longer is a Development stage enterprise. Thus , due to above accounting anomaly, Accounts prepared under Indian GAAP , contain  higher charges to depreciation which are to be adjusted suitably under US GAAP adjustments for indirect preoperative expenses and foreign currencies.

19. Employee benefits: Under Indian GAAP, provision for leave encashment is accounted based n actuarial valuation. Compensation to employees who opt  for voluntary retirement scheme can be amortized over 60 months.  Under US GAAP, provision for leave encashment is accounted on actual basis. Compensation towards voluntary retirement scheme is to be charged in the year in which the employees accept the offer.

20. Loss on extinguishment of debt: Under Indian GAAP, debt extinguishment premiums are adjusted against Securities Premium Account. Under US GAAP, premiums for early extinguishment of debt are expensed as incurred.   

21. Revenue Recognition :  Under Indian GAAP Revenues are recognized when all significant risks and rewards of ownership are transferred or on a percentage of completion basis. No detailed industry specific guidelines is available. However under US GAAP, Industry specific revenue recognition guidelines is available.

22. Comprehensive Income :   Under US GAAP, unrealised gain/loss on investment and foreign currency transalation disclosed as a separate component equity. However, under India GAAP, no such disclolsures required.

23. Business Combination : Indian GAAP restricts the use of pooling of  interest method to circumstances which meet the criteria listed for an  amalgamation in the nature of a  merger.  In all other cases, the purchase method is used. However, under US GAAP, only accounted for by the purchase method. Several differences can  arise in terms of date of  combination, calculation  Of share value to use for purchase  price, especially if the I-GAAP method is ‘amalgamation’.

24.  Property, Plant & Equipment :  India GAAP use historical costs or revalued amounts. On revaluation, an entire class of assets is  revalued, or selection of assets for revaluation is made on a systematic basis. No current restriction on frequency of valuation. US GAAP, Revaluations not permitted. Tested for impairment whenever events or changes in circumstances indicate that its carrying amount may not be recoverable

25.  Share Issue Expenses :  Indian GAAP may accounted for as deferred expenses and amortized and same for US GAAP too.

26.  Dividends :  Under India GAAP dividends are reflected in the financial statements of the year to which they relate even if proposed or approved after  the year end, but under US GAAP dividends are accounted for when  approved by the Board/shareholders. If  the approval is after the year end, the  dividend is not considered as a subsequent event to adjust the financials

27.  Lease :  Both under US and Indian GAAP leases are classified as capital and  operating leases as per certain criteria.  Capital leases are included under  property, plant and equipment of the lessor.  Lease rentals on operating leases are expensed as incurred. Quantitative thresholds have been defined.

28. Prior Period Adjustments :   Under  Indian GAAP, Prior period items are separately disclosed in the current statement of Profit and Loss together with their nature and  amount in a manner that their impact on current profit and loss can be perceived. However, under US GAAP, Correction of an error in previously issued  financial statement is recognized by  restating previously issued financial  statements.

29. Related Parties : Indian GAAP related parties determined by ability to control or to exercise significant influence over the other party. Detailed disclosure required of all material related party transactions. Mandatory for listed companies and companies meeting certain turnover threshold. Under US GAAP, related parties are determined based on common ownership and control.  Disclosure required of all material related party transactions, in particular,  the nature of relationship involved, a description of the transactions, the amounts of the transactions, the amounts of the transactions for the financial year and the amount due from or  to related parties at the end of the financial year

30. Stock Options to non employees : There is no such guidelines under Indian GAAP, but under US GAAP, a complex guideline is available.

31. Stock based compensation :  Under Indian GAAP, SEBI requires compensation cost to  be recognized based on intrinsic  value or fair value. Not mandatory  for un-listed companies. However, US GAAP had similar rules as what  SEBI later required. However, there is new standard effective 2005,  which requires fair value to be expensed for all options.

32.  Segmental Information :   Specific requirements govern the format and content of a reportable segment and the basis of identification of a reportable  segment in Indian GAPP. The information for disclosure is to be prepared in  conformity with the accounting standards used for the company as a whole. Under US GAAP, disclose revenues, profits and  assets identified by product and geographically of each reportable segment. Segments based on  information reviewed by CODM (Chief Operating Decision Maker)

33. Current Liability : In US, the current portion of any long term debt is taken as current liability, while in Indian GAPP, there is no such requirement and hence the interest accrued on this long term debt is not taken as current liability
     
34.  Interim Financial reporting:    Under Indian GAAP, Only an enterprise desirous of preparing interim financial statements is required to comply with the statement on interim financial reporting. Minimum requirements include balance sheet, P&L a/c and cash flow statement (if applicable) in condensed form. Form and content should confirm to requirements of Annual financial statements. Quarterly interim financial reporting mandatory for listed entities; minimum contents specified by SEBI.  Under US GAAP, If issued, the contents of interim  statements are prescribed andbasis should be consistent with fully ear statements. Quarterly reporting also necessary for SEC registrants (domestic US enterprises only).

35. Post Balance sheer events :  both under US & Indian GAAP, adjusting events which occur after the balance sheet date are defined as events which provide additional evidence of conditions which existed at the balance sheet date and materially affect the amounts included. The amounts recognized in the financial statements must be adjusted to reflect adjusting events after the balance sheet date. For Non adjusting events,  which occur after the balance sheet date are defined as material events occurring after the balance sheet date, which concern conditions that did not exist at the balance sheet date. The nature and estimated financial effects of such events are disclosed to prevent the financial statements being misleading

36.  Discontinued Operations : Please refer the table below to understand the difference

Issue	Indian GAAP	US GAAP
Definition.	Separate major component	Identifiable component representing major class of business.
How discontinued.	Either substantially in its entirety or piecemeal or through abandonment.	Has been or will be sold, abandoned or otherwise disposed of.
Envisaged timescale.	Over several months or longer but pursuant to a single plan.	Completed within a year of measurement date (date of management’s commitment to discontinuance plan).
Starting date for disclosure.	From the date on which a formal plan of disposal has been announced.	From the date on which management has committed to a formal plan of disposal (announcement not required).
Measurement.	Follow other standards e.g. on provisions and impairment.	Measure gain or loss on discontinuance at measurement date, including provisions for operating losses and estimated loss on disposal. Recognise gains when realised
Presentation.	Continue to consolidate as normal until discontinuance completed, with additional disclosures on face of the income statement or in notes – see below.	From measurement date, present result from operations of discontinued component (and gain or loss on disposal) as separate lines in the income statement, net of tax, after income from continuing operations. Balance sheet consolidation as normal, if discontinuance not completed by period end.
Ending date of disclosure.	Until completion of the discontinuance.	Same as Indian GAAP
Disclosures – where.	Face of the income statement or In notes to accounts.	Notes to accounts.

37. Earning per share : The Basic EPC both under India & US GAAP are calculated as profit available to common shareholders, divided by the weighted average number of shares in issue during the period. Shares issued as a result of a bonus issue are treated as if in issue for the whole year. Bonus issues occurring after the year-end must be incorporated into the calculations. For rights issues a theoretical ex-rights formula is used to calculate the bonus element. Comparative EPS is adjusted for bonus issues and rights issues. And diluted EPS There is no “de minimis” dilution threshold below which diluted EPS need not be disclosed. For diluted EPS, earnings are adjusted for the after-tax amount of dividends and interest recognised in the period in respect of the dilutive potential ordinary shares and for any other changes in the income statement or expense that would result from the conversion of the dilutive potential ordinary shares. The conversions deemed to have occurred at the beginning of the period or, if later, the date of the issue of potential dilutive ordinary shares.

38.  Hyper-inflationary economy measurement:

39.  Deferred Income Tax :  Please refer the table below to understand the difference

Issue	Indian GAAP	US GAAP
Tax rates.	Tax rates and tax laws that have been enacted or substantively enacted.	Use of substantive enacted rates not permitted. Tax rate and tax laws must have been enacted.
Recognition of deferred tax asset.	Deferred tax asset must be recognised if it is probable that sufficient taxable profit will be available against which the temporary difference can be utilized.	A different approach is used. Deferred tax asset recognised in full but is then reduced by a valuation allowance if it is more likely than not that some portion or all, of the deferred tax asset will not be realized.
Disclosure - Current/non-current.	Deferred tax assets and liabilities must only be classified as non-current.	Deferred tax assets and liabilities must either be classified as current or non-current based on the classification of the related non-tax asset or liability for financial reporting.

40.  Provision & Contingencies :   For India GAAP, it is a potential obligation whose outcome will be confirmed only on the occurrence or non-occurrence of uncertain future events outside the entity’s control. A present obligation that is not recognised because it is not probable that there will be an outflow of economic benefits or, the amount of the outflow cannot be reliably measured. A contingent liability is disclosed unless the probability of outflows is remote.  For US GAAP, the treatment is similar to Indian GAAP, requiring an accrual for a loss contingency if it is probable (defined as likely) that there is a present obligation resulting from a past event and an outflow of resources is probable. 

41. Contingent Asset :  Under Indian GAAP, Contingent gains are not recognised in financial statements since their recognition may result in the recognition of revenue which may never be realised. However, when the realisation of a gain is virtually certain, then such gain is not a contingency and accounting for the gain is appropriate.  However, under US GAAP, Is a possible asset that arises from past events, and only the occurrence or non-occurrence of one or more uncertain future events, not wholly within the entity’s control. When the realisation of the associated benefit, such as an insurance recovery, is virtually certain, the item is recognised as an asset. 

42. Control vs. risks and rewards :  Under Indian GAAP, no such issue is specifically addressd, whereas as per US GAAP, financial asset (or a portion thereof) must be removed from the balance sheet when: the entity realises the rights to benefits specified in the contract; the rights expire; or the entity surrenders or otherwise loses control of the contractual rights that comprise the financial asset. The following factors are evidence of surrender of control:

·        the transferee has the right, free from any constraints, to pledge or exchange the assets; and 

·        the transferor does not maintain effective control over the assets transferred, i.e. there are no repurchase clauses (unless the asset is readily obtainable in the market or the re-acquisition price is fair value at the time of reacquisition).

However, for non-traded assets there is a further test that some substantive risk has been transferred.

If the asset is derecognised on sale to a Special Purpose Entity (SPE), there may nevertheless be a requirement to consolidate that SPE.

On derecognition, the difference between the amount received and the carrying amount of the asset is recognised in the income statement.

Any fair value adjustments on the assets formerly reported in equity are recycled to the income statement. Any new assets or liabilities arising from the transaction are recognised at fair value.

 

43. Inventories :  Under Indian GAAP,  Carried at the lower of cost or net realisable value (being sale proceeds less all further costs to bring the inventories to completion). Reversal is required for a subsequent increase in value of inventory previously written down. Broadly consistent with India GAAP, the US GAAP in that the lower of cost and market value is used to value inventories. Market value is defined as being current replacement cost subject to an upper limit of net realisable value and a lower limit of net realisable value less a normal profit margin. Reversal of a write down is prohibited. Kindly note that under Indian GAAP, LIFO method is not allowed.

In case you have any further clarification, feel free to contact me at taxbymanish@yahoo.com or else you can view more articles & news related to Indian tax & finance at http://taxbymanish.blogspot.in/.

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