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Total Number of Subscribers: 428 |
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Date: 2 June 2008 |
Compiled by Mr. M. Sathya Kumar |
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Accounting
standards — Debits and credits
of harmonising Recently, the Institute of Chartered Accountants of India (ICAI)
set up a task force to examine full convergence of Indian accounting
standards with the International Financial Reporting Standards (IFRS).
According to an ICAI press release, "Full convergence would involve
adoption of IFRS in the same form as that issued by the International
Accounting Standards Board (IASB)." What are the implications of adoption of IFRS? Who benefits and
what are the costs? How should we go about this exercise? What additional
institutional reforms do we need to make this exercise meaningful? The ICAI's announcement is a landmark
in Indian accounting regulation. It is a clear signal that the accounting
profession is coming to terms with the globalisation
of Indian business. Also, it winds up the ICAI's
project of establishing Indian accounting standards. Unfortunately, this
project has been often used to dilute the IAS than to make any meaningful
adaptation of the administrative services to suit special Indian
circumstances. Full convergence would be a welcome step and it should happen
early. The decision to adopt IFRS has major public policy implications and
will particularly impact India's systems of accounting and disclosure,
corporate governance, tax/company law and securities regulation. Demand for High-quality Financial Reporting Increasingly, Indian accountants and businessmen feel the need
for convergence with IRFS. Capital markets provide an important explanation
for this change. Some Indian companies are already listed on overseas stock
exchanges and many more will list in the future. Internationally-acceptable
accounting standards will then become the language of communication for
Indian companies. Also, the recent stream of overseas acquisitions by Indian
companies makes a compelling case for adoption of high quality standards to
convince foreign enterprises about the financial standing as also the
disclosure and governance standards of Indian acquirers. Product markets are
also an important influence on decisions to adopt international accounting
standards. Overseas customers dealing with Indian firms are concerned with
the companies' financial performance, especially when long-term relationships
are involved. Also, the labour market influences financial
reporting quality in several ways. Indian firms need global talent to stay
ahead of the competition in their product and capital markets. Superior financial reporting could be useful in convincing a
firm's present and potential employees of its financial soundness, so that as
key users of a firm's accounting information they can trust the firm as a
dependable employer. The rising use of pay-for-performance plans and the need
for international tradability of employee stocks and stock options further
underscore the need for respectable accounting rules. The Challenge for Indian Accounting
Regulators Convergence with IFRS would require several changes in Indian
laws and decision processes. As the Companies Act stands now, the Central
Government has the power to promulgate accounting standards. The proposed
adoption of IFRS will change this because it will not be possible to depart
from the IFRS. I use two examples to illustrate the implications of IFRS for
the Indian company law. Schedule VI to the Companies Act lays down the form
of the balance-sheet and a departure is allowed only if it is a must.
Accounting Standard 11, dealing with the effects of changes in foreign
exchange rates, was revised in 2003 to eliminate the earlier practice of
adjusting the cost of fixed asset acquired with a foreign currency loan when
there was a change in the exchange rates. The reason for the revision is that
such a change in the liability does not change the operating/earning capacity
of the asset and, therefore, the related gain or loss on the liability should
be taken to the profit and loss account. Also, it is now possible to hedge foreign currency liability and
the hedging cost is a financing cost. The revision harmonises
AS 11 with IAS 21 and definitely represents better accounting but since
Schedule VI retains the old practice, this revision cannot be implemented. Substance over form Accounting standards emphasise the
importance of the economic substance of transactions over mere legal form,
but here again the rigidity of Schedule VI is problematic. For example, the
terms of preference shares often place them closer to debt than to equity.
Yet, Schedule VI requires them to be classified as equity, going only by
their legal form and in complete disregard of their economic substance.
Again, convertible debentures should be split into debt and equity components
but must be classified as debt under Schedule VI. There are also a number of other problems with many other
schedules and provisions, such as Schedule XIV on minimum depreciation rates
and definition of subsidiary. Banks and insurance companies have special
forms for financial statements and these too pose difficulties. If IFRS are adopted, IAS 1 Presentation of Financial Statements
and other standards will take precedence over the Schedule VI form. One way
is to amend Schedule VI every time an IFRS requires a different presentation.
Technically, it is not difficult as a schedule can be amended by the
government by a Gazette Notification. However, the Government has not come
out with a new Schedule VI despite the ICAI's
persistent efforts, suggesting that the process of change through the
administrative system is not simple. A better approach would be to specify
the minimum level of disclosure for the balance-sheet (as is currently done
for the profit and loss account) and leave the form of presentation to IFRS. True and fair view The touchstone of "true and fair view" in financial
reporting would require a relook if IFRS are to be
effective. As the law stands now, it is possible to invoke a true and fair
view override when compliance with the requirements of an accounting standard
conflicts with the test of true and fair view. A far-reaching amendment that
financial statements shall not be deemed to give a true and fair view unless
they comply with IFRS has to be a part of the proposed reform. A related problem is the role of the judiciary in enforcing
accounting standards. Companies have questioned the applicability of
accounting standards (for example, some leasing companies have obtained an
interim stay on the operation of AS 22 on deferred tax). We can expect more
such cases when IFRS are made applicable. The courts will have to decide such
cases expeditiously with help from experts. With the introduction of the Minimum Alternative Tax, the
determination of accounting profit is also of great interest to the
income-tax authorities. The adoption of IFRS will likely result in earlier
recognition of expenses and losses and asset write-downs and could adversely
affect MAT collections. Needed, Shareholder Litigation Prof Ray Ball of the University of Chicago argues in a Brookings
Institution paper that adoption of IFRS by Chinese companies and even
auditing by reputed accounting firms has not improved accounting quality
much. In contrast, companies that are listed in Hong Kong or in the US
have superior accounting quality because of the operation of stringent
investor-protection laws, liberal shareholder litigation, and efficient court
systems. Raising the risk of shareholder litigation will greatly improve the
quality of managers' and auditors' compliance with IFRS. The proposed reform should be accompanied by a recognition of
the rights of individual shareholders to sue directors and auditors for
wrong-doing. Without these and other radical institutional reforms, the mere
adoption of IFRS will do India no good. On the contrary, we will end up with
financial statements based on high standards that are applied inconsistently
and improperly. Low quality financial statements that convey a false
assurance of high quality would be more dangerous. Courtesy : Mr. Narayana
Swamy, Article earlier appeared in the Business
Line, a financial daily of the Hindu Group |
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