I. Some macro issues:
Accounting year :
1. Normally every sovereign state provides a legal framework to decide about the accounting year. Every entity carrying on a business is required to prepare the final accounts as understood by us for pre-defined accounting year. Besides annual report to various stakeholders, collection of tax revenue is also based on this pre-determined accounting year. In India, such an accounting year is financial year starting from 1st April and ending on 31st March. Earlier in India, sentimental luxury relating to choice of an accounting year was given to every business entity. No longer is such a luxury permissible.
2. However, business entities are no longer national but one invariably finds a multinational or a conglomerate of cross-border holding/subsidiary and associate companies. When different countries have different accounting years, there is a perpetual problem of consolidation of group accounts. One will argue that a good business entity would be, in any case, preparing quarterly accounts for presentation to various stakeholders. Once quarterly accounts are made available, consolidation is merely an exercise of year on year inclusion and exclusion of either one quarter or at the most two quarters.
3. Year-end consolidation exercise, however, is not a simple arithmetical affair but involves lot of work. The question is “What is the value addition” as a result of this avoidable exercise ? When the world community is accepting a common accounting language, should one not address this issue ? I submit that at a macro level, it is necessary to have a debate and discussion and the issue needs to be sorted out amicably. Government budget in our country used to be presented in India at 5 p.m. on 28th February, every year, because time zonewise it suited British colonial rulers for whom it used to be 11 a.m. We continued this practice for almost over 50 years after independence. It is an example of how in some convenient matters we choose to be rather causing inconvenience perpetually.
II. Currency expression of accounting figures :
The illustrative schedule of Comprehensive Income Statement and Statement of Financial Position as per IFRS are figures expressed in thousands of currency unit. It would mean expressing the figures in millions and billions and trillions. In India, we enjoy the luxury of expressing figures in units, hundreds, thousands, lacs and even crores. There is no uniformity. Do we wait for legal compulsion or would like to follow what is globally acceptable and understood ? I submit that this apparently no impact area from the point of view of results of operation needs to be changed so as to conform to the International Standards.
III. Presentation of annual report :
An annual report is required to be presented to all the stakeholders who are not necessarily shareholders. How should the annual report look like ? Although it is a mandatory requirement as to what should appear in annual report, there are companies which provide certain information on voluntary basis. However, one finds a lot of diversity in use of paper, use of type-setting, use of photographs, order of contents, etc. One must have come across annual reports where not only the quality of paper is very poor, but the type-setting is such that one cannot read without a binocular. This is the information which the stakeholder is expected to read. I remember a couplet written in the context of a prospectus and some of the poetic lines are as under :
Before you invest, read the Prospectus,
It provides information, which is given to protect us.
Summarised in it are all the figures which are composed.
It contains all the risks to which you are exposed
Don’t you know where to start ?
Smaller the print, greater the hazard.
Well, I do not mean that in every case a small print is a hazard (except to your eyesight), but standardisation in this apparently no operational impact area is also necessary.
IV. Limitations of written figures :
1. Many times, the figures may not convey full meaning and disclosure by way of written text without a legal compulsion may not be forthcoming. I believe that even IFRS contains such areas. Alternatively, the meaning would materially change with context explanation. Some years back, a theatre personality was being interviewed on TV. A simple sentence of 3 words ‘Police caught thief’ was shown by him to have 3 different meanings depending on which word you emphasise; and with different body language, he showed 10 more meanings of a simple sentence of 3 words.
2. It is not the purpose of this article to write specifically about what happened in Satyam. That would be a matter of a separate article involving lot of debate and discussion and even perhaps a shock treatment. However, I do reiterate that IFRS compliance is not much of a difference qualitatively from classical accounting theory, but a classical example of how to make simple things look extremely complex. And yet could be far away from transparency, accountability due to window-dressing. I write this because ‘Satyam’ claimed to be the first company to be IFRS compliant three years ahead of the date of its applicability and its annual report for the year ended 31-3-2008 on pages 125 to 167 contains complete conversion of accounts if IFRS is followed.
V. Adoption, adaptation and convergence :
1. News from USA :
The discussion between IASB and FASB continues. Just as we have political and economic summits, the two bodies met and entered into what is known as ‘Norwalk Agreement’ in 2002. At the end of the summit they made joint announcements that they would undertake some joint research projects to iron out difference between the two, some projects would be short term; others may take little more time. In substance, they agreed that they should be together in long term in defining and dictating (in a nice way — no pun intended) the world accounting language. I am reminded of a famous satirical novel ‘Animal Farm’, written by George Orwell where you get a message that “all animals are equal but some are always more equal than others”.
2. Process of unification :
As a part of a move to extend a co-operative hand, SEC in the USA will review the faithfulness and consistency of foreign private issuers IFRS compliant Financial Statements from 2005. SEC issued a statement around that time that if few areas are looked into, SEC will not insist on reconciliation of IFRS compliant accounts with US GAAP, for US listing. This would avoid multiple accounting presentations. On its part, IASB also modified its several standards in line with US GAAP. As a result of the process, IASB assumes that countries will adopt IFRS “as issued by IASB without any modification”. This is based on the theory that IASB adopts some US GAAPs; some areas are jointly researched and issued as new IASB, other complicated and complex areas would be soon investigated to iron out the differences and then world accounting language would be the same.
3. Position in EU countries :
(a) Countries in EU (European Union) have made IFRS mandatory for all listed companies and it is reported that starting 1st January 2005, 8000 EU listed companies adopted IFRS and proposed listed companies will follow suit.
(b) Beyond listed companies, however, there appears to be a lot of confusion. Out of EU countries, only Greece, Italy and Denmark (effective from 2009) require IFRS for individual accounts of listed companies and none of them require it for non-listed companies. Germany allows companies to provide individual accounts using IFRS, but still requires them to prepare primary statements following German National Standards. Newly joined 10 countries in EU also require annual statements according to their own national accounting standards — a system of dual accounting (national and international standards !). National pride continues and legal adoption is still delayed. Some countries would like to adopt IFRS one by one and not as a package. In Europe, there are IASB approved IFRS as well as EU endorsed IFRS, besides national accounting standards. Each of these serve a different purpose for different state of stakeholders. Though statements continue to be issued from time to time, the picture is far from clear and although a road map is constructed, there is always a difference between a map on a paper which looks very clear, and the actual road which is not an expressway or freeway. It has lot of potholes, blockages and rough patches.
4. Indian scenario :
Our Institute (ICAI) is awakening members, holding seminars, workshops for them. What was a trickle in 2007-08, is likely to become a flowing stream, but with a restricted speed. The members are bound to follow ICAI with respect and would become as usual, studious students. The revenue departments, the company law department and various industry associations, however, are still not enthusiastic supporters. The recent ‘Satyam Episode’, where the company claimed to be the first to be IFRS compliant, would also come in the way of proper studies because lot of defense mechanism will have to be used in damage control exercise. Regulatory authorities also may put lot of hurdles with justifiable reasons. One of the principles of investigation is ‘Distrust the obvious’ and that would come in the way of smoother regulatory work for some time. Members of the public would say with one voice, “Let the accounts be basically transparent” — whether they are Indian GAAP compliant or IFRS compliant or US gaap compliant can be examined later.”
VI. Micro level simple examination of a part of Accounting Standard :
1. Having examined some macro issues, let me turn attention to a specific Accounting Standard, namely, Revenue Recognition (AS-9) to examine the Standard with reference to :
(a) Accounting Theory and Practice.
(b) IAS Standard.
(c) IFRS Requirement
2. Case study accounting theory and practice : As a case study for the purpose of this examination, I have taken a very simple example of sale of goods on credit, pure and simple. ABC Ltd. has sold goods worth Rs.50 crores to 100 different customers. Since these are the goods manufactured by ABC Ltd., beside sales price, the actual invoices also include excise duty and Vat at 16% and 12%, respectively. The credit term is 30 days and interest is to be charged @ 18% p.a. for non-payment in time. I am not involving additional complications such as export sales or sales out of the state, in our own country, but both these may be having implications in collection of indirect tax revenue with exceptions and exclusions on specific grounds.
3. In such a scenario, the accounting theory and practice, which is age-old and based on common sense and business experience and wisdom has taught us that
(a) Revenue generated is to be taken to the credit of profit and loss account to the extent of Rs.64.96 crores.
(b) Amount receivable at the end of the year is to be shown sundry debtors on the asset side, under the heading current assets exactly to the same extent.
(c) Mercantile system of accounting is to be followed.
(d) Actual bad debts must be written off.
(e) Depending on experience, a provision must be made for doubtful debts.
(f) If there is a policy, a provision is to be made for discount on prompt payment of debtors.
(g) A businessman should be conservative, i.e., he should quickly recognise losses and expenses, but should be slow in recognising possible gains. Interest on delayed payments by debtors is normally accounted for on actual receipt basis.
4. In accordance with the above principles, the businessman would pass the accounting entries and each of the entries that he passes, there would be impact on the actual revenue to be recognised and also debtors in the form of current assets to be shown. The conventional presentation, however make all fluctuating adjustments on the debit side of profit and loss account, without touching the figure of revenue by way of sales recognised. However, in the case of presentation of debtors, on the asset side, he would make all the adjustment to the figure of debtors. Common sense, uniformly applied acquires the force of law and Sch. VI, Form of profit and loss account and balance sheet also required us to do the same thing over a number of years.
5. Other permutations and combinations of accounting entries would follow depending on varying degrees of a contract of sale (Basically governed by the Sale of Goods Act.) Theses variations as per the Sale of Goods Act would not materially be different than the accounting entries as mentioned in para 3 above. However, for the sake of completeness, they are just narrated below :
(a) Changes in delivery schedule
(b) Conditional delivery subject to installation and inspection
(c) Sale on returnable/approval basis
(d) Hire-purchase sales.
(e) Sales where there is time-bound after-sales service and guarantee
(f) Consignment sale
(g) Transit insurance claim as a result of loss of goods.
VII. Requirements of AS-9 :
1. If one goes through the actual standard parameters, it has accepted the conventional wisdom in its complete form, except for the fact that it has tried to visualise as many different possibilities as possible. Such an attempt at detailing, to my mind, is an attempt to make every businessman an ‘Arjun’ who could pierce the eye of a moving fish, by looking at its mirror image. Alternatively it could also be contended to be an attempt to count feathers of a flying bird.
2. The only difference is treatment of Indirect Taxes like State-level Vat and Central Excise Duty. The guidance note issued by ICAI on treatment of State-level Vat tells us that no economic benefit is earned by an enterprise in collecting and paying Vat on behalf of State Government and hence from the total turnover, State-level Vat should be excluded and the payment thereof should also not be taken as expenses. In our above illustration, 6.96 crores being Vat collection will have to be excluded and the turnover should be shown at Rs.58 crores. Adjustment arising out of input credit on Vat should be made in the purchase of goods shown on the debit side of the profit and loss account.
3. In case of Excise Duty however, it has been held to be a manufacturing cost by the decision of various courts, but instead of showing it on the debit side of the profit and loss account, it is required to be shown as a deduction from the turnover. As a result, on the credit side, one is expected to show turnover at 58 crores less ED Rs.8 crores and the net figure of 50 crores is to be shown. In addition to this there would always be some difference in the opening and closing inventory of finished goods which must be inclusive of Excise Duty and the difference between closing and opening inventory. Excise Duty of finished goods should be shown either on the debit side or the credit side separately and should not be mixed with the turnover, or with Excise Duty deducted from it.
4. There is no requirement of fair valuation of debtors because debtors is not treated as a Financial Instrument. However, AS-1 ‘Disclosure of Accounting policy’ would invariably contain a statement indicating that adjustments are made to the realisation probability of debtors based on past experience on grounds of conservative policy.
VIII. IAS and IFRS requirement :
1. Every standard contains essentially 4 ingredients, namely :
(b) Disclosure policy
(c) Recording of transaction
(d) Presentation in final accounts
2. It is a nice way of presentation and makes understanding of a standard easy. IFRS and IAS is no exception and our AS also follows the same policy. Some standards are pure standards of disclosure, whereas in some standards one would come across a combination of all the 4 ingredients.
3. In IFRS and IAS, our conventional dear ‘Sundry Debtors’ and ‘Sundry Creditors’ of so many years would acquire a new name of ‘Accounts Receivable and Accounts Payable’. They would acquire a new status of a ‘Financial Asset’ and since it is capable of being sold or bought in the market by way of securitisation, they would get a further status of a ‘financial instrument’. An instrument could be tangible or intangible and capable of being stated cost less estimated expenses of realisation or could be valued under ‘Valuation Rules’ in the absence of a market and could be valued at market value if there is an active market for it. So our figure of conventional ‘Sundry Debtors’ of yester-years would get a designer status due to different clothing and make up, and naturally its valuation would always present lot many difficulties.
4. It is not my intention to describe the entire dress material, but the essential thing appears to be a quick attempt to convert everything into an instrument so that it could be sold, it could be provided as a margin and could also be used for the purpose of leveraging, so as to have the fastest of turnover of these figures involving mark-to-market valuations. Most of the complications are the result of this exercise which is required to be carried on when we turn to IFRS. Such an exercise will require mathematical modules.
IX. Limitations and reservations on IAS, IFRS :
Having examined a part of a standard AS-9 from a very limited angle, although it may be considered very late, I would like to express some limitations and reservations which are bound to be faced in the years to come and some of them could be listed as under :
1. The exercise in making a fair valuation is going to be a very subjective affair and what is described as fair value would be based on many assumptions incapable of remaining true in a dynamic business scenario.
2. Whereas common accounting language need not be a utopia, it should be a gradual process of adaptation one by one or a group of standards instead of a total adoption at one go from a predetermined date. Our ancestors have told us that one morsel of a food should be chewed 32 times before we take the second, so that the food is digested properly. If we gallop the food of these IFRS and that too imported food, we could be suffering from indigestion and all other diseases.
3. If substance over form is to be accepted as a proper understanding of a subject and if we want to prepare the accounts which are not only rule-based but based on the underlying intention, then there is no distinction between Excise Duty and state-level Vat. If the Vat does not have any economic benefit for an enterprise and therefore needs to be excluded from turnover and also as an expense, then the same logic in substance can also be applied to Excise Duty. Different treatment for different elements of indirect tax appears difficult to digest and lot of time is wasted in trying to make these niceties in accounts rather than going into the business substance of the results of the operations. If only some more vigilance was shown by those connected with Enron, Worldcom or Satyam in finding the substance of the business rather than spending time in making the accounts IFRS compliant or US GAAP compliant, stakeholders at large would benefit and would curse the accounting less than what is done today.
4. Although there was a lot of pressure on our government and RBI to make the rupee fully convertible in late 90s including some intellectuals from our country, our RBI did not do it and we were spared from the currency crisis of late 90s in South-East Asia. This is the recent history. Most of our banking sector top brass taking decision is above the age of 40 and they do not fully understand currency derivatives and all other derivatives and mark-to-market mechanism fully. We are therefore substantially saved from the ‘Sub-prime’ crisis which has engulfed US and Europe although our country is also affected to some extent. People say that we were saved because of our relative ignorance in new financial instruments.
5. There is another reason for advocating adaptation stagewise instead of adoption. The main reasons for reservation on a national basis emanates from a fear of tax laws. Fiscal policy in any country determines the taxation policy – whether direct or indirect. It is accepted in a pure Brahminical way that Accounting Standards are basic accounting principles and they cannot be in any way remain fluctuating with a yearly fiscal policy with consequential changes in tax laws. However one cannot afford to totally neglect the strong feelings of a business community to prepare accounts in compliance with taxation laws to avoid conflict and tax litigation. Even in Europe the national spirit and multiple accounting standards is the result of tax orientation of a nation. One cannot neglect this tax consideration altogether.
6. The standard-setting exercise appears to be an intellectual exercise of bodies handed over to the fellow members without many times active support either from the Government or the business community. If it was not so, there would not have been such a resistance. How many years you have read notes on accounts stating that “Inventory of finished goods is exclusive of Excise duty. This is contrary to the Accounting Standard issued by the ICAI. However it has no impact on the profits of the year”. Business community was doing it only for the purpose of improving their ability to get higher working limits from the banks.
7. Feelings expressed in above paras are not only the feelings as a CA, but these are the feelings heard from a small and medium-size business entity with which I have spent a lot of time. It is felt many times that the complicated standards are only a burden on the accounting profession, because the business entities do not many times see any value addition to the exercise, but their voice does not get heard under the weight of what is ‘Big’ in every sphere.
X. Conclusion :
1. It is not the intention of this article either to downplay the AS, IAS or the attempt at convergence to make IFRS the world accounting language. However, a mathematical model required visualising every possible situation is bound to be a complex exercise when the global business itself is very dynamic. It is not only dynamic in value and volume, but is also largely unpredictable and based on shifting sands of precarious nature and future. Moreover I refuse to believe that stakeholder in a globe is a dumb animal who needs to be fed every bit of a detail. One should believe in his intelligence to make proper adjustments required to safeguard his own stake subject to normal risk. In such a scenario, a gradual adoption after proper understanding may be a better alternative rather than full and complete adoption at one time. A longer courtship and dating may be a better idea to a love at first sight and marriage. Otherwise, there could be more chances of a divorce petition or a discord affecting marital bliss.
2. Even in the absence of a common language, a true love and affection between a man and a woman could flourish and let Adam eat the prohibited fruit to get his Eve and suffer the consequences. This is not only true for love making between a man and a woman, but also is true for love and affection in every human being. What is required is a standard of human integrity and this is something which cannot be laid down in black and white in any common language but is something, which is required to be examined and felt on an ongoing basis. This requires avoidance of greed and fear and building a confidence level, irrespective of a language barrier. Do you get me my dear friends?
Author/s : Ashok Dhere, Chartered Accountant