A seat at the high table

Last month witnessed two significant events essential for the coming of age of the Indian accounting profession.

To start with, The Institute of Chartered Accountants of India (ICAI) signed an MoU with the Institute of Chartered Accountants of England & Wales (ICAEW) permitting the members of either institute to acquire membership of the other by clearing a minimal number of exams. This, definitely, is a great achievement for the ICAI, and the entire leadership behind it deserves to be congratulated. This is a goal, which was being pursued for more than one and a half decades. Mutual recognition between India and the UK was undone in the early ‘90s by measures taken by the Board of Trade in the UK and the Indian leg of the recognition was withdrawn in the mid ‘90s. At the same time when industry, trade & commerce was increasingly becoming borderless, Indian accountants were fenced within the political boundaries of India. This MoU has the potential of defeating the isolation decade and making the Indian profession become a truly global player.

The European Commission (EC) made a landmark announcement last week. The Generally Accepted Accounting Principles (GAAP) of six countries in the world — United States, Japan, Canada, India, China and South Korea — were declared to be equivalent to International Financial Reporting Standards (IFRS). This followed a positive opinion given by the European Parliament and all member states to the European Securities Committee in the previous month. While this is a testimony to the application and rigor of Accounting Standards in India, it also acknowledges the fact that the fundamental genetic material of Indian accounting standards are the purveyor of IFRS.

Though these developments would definitely bring cheer in these gloomy times, but at the same time, there is a pertinent clause added to it. In its announcement, the EC said that the situation in four of these six countries, i.e., India, China, Canada and South Korea, would be reviewed no later than 2011. Also the EC would regularly monitor the ongoing status of equivalence and report to the member states and Parliament. Thus, we cannot remove our foot from the accelerator of convergence to global standards.

India’s growing clout in the accounting world has a lot to do with its status as an emerging economy with a strong growth rate and deep-pocket investors who are venturing abroad. It is a matter of pride that India has more than 200 companies, many of them medium sized, whose debt or equity is listed in Europe.

Membership of this exclusive club brings many responsibilities and expectations. In addition to converging with IFRS by 2011; and continuing to satisfy EC equivalence criteria in the forthcoming equivalence tests, we would have to converge our auditing standards, - particularly the standards for joint audits. The market place, regulators and ICAI will have to move towards the international goal of ‘qualification free’ public balance sheets, where accounts are recast in order to remove audit qualifications before they are accepted in a public domain. The MCA in its new Companies Bill has proposed independence requirements, which would help in achieving convergence with global independence standards. The logical extension of all such convergences is to encourage multi-disciplinary partnerships and the government has already done its bit by amending the CA Act to permit it.

This week, the Securities Exchange Commission (SEC) has also voted on the necessity of its 500 largest companies to file financial reports from 2009 using the Extensible Business Reporting Language (XBRL). Similar adoption of XBRL by a number of the other developed countries would mean that India would also have to soon walk on that path. Sebi has already constituted a committee and I feel, this will be the next big thing that will occupy our attention.

A seat at the high table comes with a lot of obligations, but also with unique opportunities. Opportunities to place the concerns of the emerging economies on the world stage; opportunities to take leadership in developing SME (Small, Medium Enterprise) focused standards; opportunities to highlight the talent in the country; opportunity to open up new horizons of global mobility for our professionals. We only hope and fervently wish that all such opportunities are grasped with both hands and we do not falter on any of the heightened expectations that the world has from us.

This article appeared in the 22 December 2008 edition of Business Standard, which is available at this link.

Expectations from the auditor and the Companies Bill 2008

The Companies Bill 2008, now pending with Parliament has initiated certain significant steps towards accountability, transparency and rationalisation of measures relating to audit and accounts. Some significant measures have been addressed by the Companies Bill 2008. It’s heartening to see that some of these are broadly in line with similar international requirements.

The Bill has notified a list of services as prohibited services that an auditor of a company can never provide. Further, the provision of prohibited services or deficiency in conducting the audit would expose an auditor to a hefty penalty and knowing or wilful contravention can additionally attract imprisonment for one year. Such a conviction would additionally require the auditor to refund all remuneration received by him to the company and become liable to make good the loss arising out of his incorrect / misleading report to any other affected person.

I believe this clause itself in the near future would perhaps lead to a great shake up within the profession. In addition, for listed companies, a framework for internal control is required to be mandated by the board and an audit certification of such internal control is separately required. By definition, every annual financial statement must be accompanied by a report of the Committee on Directors’ Remuneration. Thus, payment to directors would come under focus.

The Bill envisages that a Chartered Accountant (CA) audit firm may also have partners, who will not themselves be CAs. This seems in line with the ICAI movement towards enabling multi-disciplinary partnerships. In a very welcome move, the government has dropped Schedule VI from the Bill and consolidation of accounts has been mandated.

These have been long awaited reform. Family-owned / closely-held businesses with complicated structuring, may find living in a regime of mandatory consolidation quite challenging. While this has been a significant initiative by the Ministry of Company Affairs, there are certain matters of detail and certain prima facie lapses in drafting of the Bill. To cite an example, contrary to international norms and existing Indian law, an auditor can now hold securities, up to prescribed levels, in the company he would audit. This appears to be a step backwards. There was a lot of disquiet on the existing law prohibiting the auditors’ indebtedness in excess of Rs 1000. Inexplicably, instead of relaxing this guideline, the threshold has been removed and any indebtedness at all has been prohibited. This would make it practically very difficult for firms to be appointed auditors of telecom, electricity and other utility companies, since normal monthly consumer bills would render an auditor ineligible. However, on a contrary note, the Bill states that an auditor can provide a guarantee or security for indebtedness of a third party and even have a business relationship with his audit clients up to prescribed limits.

The Bill requires the auditor to report whether financial statements comply with ‘auditing standards’. This is a clear error since financial statements are drawn up as per ‘accounting standards’ and have nothing to do with auditing standards. There is a responsibility cast by the Bill on the auditor to provide in his report, “any qualification or adverse remark relating to the maintenance of accounts and any other matters connected therewith”.

KEY PROPOSALS
* Only the boards of companies can pre-approve any additional services that an auditor can render and a list of services have been notified as prohibited services
* A Chartered Accountant audit firm may also have partners, who will not themselves be Chartered Accountants
* The Bill requires the auditor to report whether financial statements comply with ‘auditing standards’. This is a clear error

Now, the last bit of this clause is too openly worded specially for a situation where a wrong auditors’ report would lead to severe penal consequences. Continuing a previous drafting error, the Bill requires the auditors to report “the observations or comments of the Auditors, which have any adverse effect on the functioning of the Company”. It is extremely unlikely that observations of Auditors will have an adverse effect on the functioning of the Company! Perhaps, the intention is to report upon those observations of Auditors, which pertain to matters having adverse effect on the Company.

It is high time this particular mistake is rectified before the Bill is enacted as Law. The Bill stops short of making the bold requirement that audit reports should not be qualified and for any proposed qualification, the management should go back and recast their accounts.

There are various disclosure requirements and provisions in the Bill which makes an auditors’ task very onerous. The basic tone throughout the Bill is one of investor friendliness and protection and the Audit profession has been called upon to assume far greater responsibilities, the downside being far greater consequences for failure. It is important to iron out the obvious minor flaws so that the broader vision laid down can be realised. I do hope the profession in our country would also prove equal to the task.

This article appeared in the 24 November 2008 edition of Business Standard, which is available at this link.

India in 2008: Treading on egg shells

When at the turn of this century our great grandchildren look back, possibly the annus horribilis, 2008 would be more of a defining point for the 21st century, than 1929 was for the 20th century.

It is difficult to predict what world order will emerge from this churning, but for a student of history it is certain that going forward the world would be a different place.
While definitely we have not yet come to a eureka moment where one can confidently predict that the Indian economy and the Indian currency would be one of the strongest in the world in the 21st century, there is ground for guarded optimism.

A very strong financial sector; strong fundamentals; a youthful nation and an economy substantially fuelled by internal consumption and capital formation. These are the foundations we are destined to build on.
At this critical point, the two things that can trip us are unjustified expectations and short-sighted leadership. I intend focusing on the former today.

We must realise there would be short-term issues this year; some of us would be affected more than others. If we anticipate and prepare for some of these issues, we can ride the gusts of wind and not rush headlong into a stampede arising from unfulfilled and unrealistic expectations. What are some of these issues?

The sources and costs of finance would be under stress and long-neglected covenants, dismissed as fine print earlier would receive greater scrutiny and could be leveraged by leaders.

Companies would have to test their compliances with financial/operational targets they had held out for. Industries hit by global recession would face sales slowdown and would have to challenge inventory obsolescence.

They would have to revisit plans for augmenting working capital; counter party risks in the form of impacted debtors may surface in balance sheets of entities in the form of receivable write-offs and stretched debtor turnover days.

Commodity, fuel and interest cost increases would lead to rise in cost of sales and compress margins. Due to this, analysts and companies would need to revisit cash flows, forecasts and performances. Resultantly, there would be a consequential impact on impairment of tangibles and intangibles. Due to contraction in demand, idle capacity costs would get charged-off, hence impacting revenues.

Suppliers and purchasers may invoke liquidated damages or delayed payment related contractual terms which in the past may have been waived. Further, the impact of maturing derivative contracts on some balance sheets would need to be closely watched. In addition, there could be short-term reduction in margins, profitability, capital expenditure, bonuses, rate in growth of salaries, stagnation in property values and consequent second-hand contraction of demand. That said it is important to realise that there is no reason for panic, while there is cause to be realistic.

This year would be quite unlike previous years. Therefore, it would be unfair for investors or the market place to get impatient and measure growth rates or results in comparison with the immediate past periods. The media would also have to factor these expectations and be more subdued in its reporting. We have to set the right tone of our expectations, only then will India be able to stand up and display to the world the resilience, maturity and depth of the Indian market. This has already been displayed by our financial sector and we must follow suit.

If we do this, we would have successfully passed the first test on our way to become leaders of the new world.
The second test that of moving beyond the bane of short-sighted leadership would require involving leaders across the political spectrum and obtaining agreement on certain common economic premises and ways of achieving them and arriving at a bi-partisan agenda, elevating this above the cut and thrust of politics.

That would in short require the emergence of an economist Gandhi — a subject beyond the modest ambitions and length of today’s column.

This article appeared in the 10 October 2008 edition of Business Standard, which is available at this link.

Great expectations

Given the initial press release by the government about the directions and the thrust of the now finalised Companies Bill, it is clear that potentially this has the ability to become the most significant piece of corporate legislation in the past few decades. From what is evident, there has been a structured thought process; targeted towards rationalisation of processes; clear separation of procedural non-compliances from substantive issues; leveraging and extending the Ministry’s highly successful e-enablement endeavours of MCA-21, for empowering corporate stakeholders.

Of particular interest would be the efforts to spark investor activism and enable investors to take part in “class action suits”. Companies, the legal systems of the country and investors would have to mature overnight in this brave new world.

From early indications, the profession of independent valuers will receive a great fillip. Right from valuation of non-cash considerations for allotment of shares to fair valuations in case of business combinations, and valuations of property, plant and equipment, intangibles, as well as off Balance Sheet assets and liabilities - valuers would play a most critical role. The valuation profession would have to step up to the plate as corporate India looks set to be entering the subjective world of fair valuation. Uniform valuation standards and oversight would be required, but above all, the country would need many more valuation professionals.

It is a bit of a let down that early pronouncements , while talking in somewhat great detail about the convergence/adoption of international best practices on trade law and valuation frameworks, skirts the issue of convergence of global accounting and auditing frameworks. There have been statements on recognition, of both auditing and accounting standards. This seems to indicate that the Act may still retain the right, to prescribe through subordinate legislation, the accounting framework. This falls short of the MCA’s self declared position of converging to IFRS by 2011. However, pending availability of the entire Act the jury is still out on this one.

Preliminary indication of procedural de-bottlenecking, like speeding up the incorporation process, removal of limits in the number of partners of professional firms, and providing a single forum for approval of all mergers and acquisitions were overdue and are welcome. But, as with most such good intentions, final judgement would await actual execution. The challenge is whether the mind sets and skill sets of the officials implementing these can be changed overnight.

When discussions on this Act begun a couple of years back, there was great focus on reducing the size of the Act and the number of sections. The temptation to achieve this by liberal use of the “as may be prescribed” phrase appears great. This would leave the door open for proliferation of rules and regulations and frequent amendments therein. If this happens, very soon we are going to land back again in a web of complexity which the present Act wants to undo.

For the first time in recent memory, initial news of the provisions in the new Act have sounded the right notes and raised great expectations. We hope we shall not be let down.


This article appeared in the 08 September 2008 edition of Business Standard, which is available at this link.

Nostradamus of the accounting world

Prescience or the ability to see into the future is a gift sparingly given to humans. It is a mixed blessing, for such people are often inadequately recognised in life. Pesi Narielvala was the only such person I was privileged to personally witness up close. A philosopher among accountants, an orator par excellence, his vision was astounding. He realised, for accounting to become a universal language, it must be codified. Single-handedly, he started the technical directorate of the Institute of Chartered Accountants (ICAI), dictating landmark professional standards such as the Guidance Note on Expenditure during Construction. This was way back in 1970, when the International Accounting Standards Board, the US Financial Accounting Standard Board and our own Accounting Standards Board were yet to be formed. The framework for Special Reports and Certificates developed by him is the only framework that even today Indian accountants rely on when issuing a certificate or even an examination report for an IPO.

At a time when it was unheard of, Pesi in his capacity as President of ICAI was instrumental in forming the Accounting Standards Board. In fact, he stood up to great opposition by the chambers of commerce and the industry to the basic concepts of standardisation. Today, when the industry and regulators have finally acknowledged the importance of standards, their justified grouses have not been heeded by anybody apart from Pesi who recognised these issues and stood by the industry despite their initial opposition towards him. In ICAI’s journal some time back, Pesi justified industries unrest regarding the accounting profession treating industries as “soft targets” while promulgating standards, but doing lesser than what it should have to “sell” these standards to the tax authorities, regulators and other groups, whose attitude towards standards compounded industries problems in implementation. Pesi was convinced that professional excellence had to receive primacy over ICAI’s tendency to seek equal distribution of work amongst its members. Not a popular view, but one which will survive the test of time. He was apprehensive about the rate of growth in the availability of information not matching with our capacity to develop applications to make meaningful use of it.

He often remarked that the complete change of mindset that technological advances warranted was not adequately evidenced since “one may change ones mind several times a day but one is fortunate to possess the wisdom to change ones mindset even once in a lifetime”. On the archaic issue of prohibition of advertising by accounting professionals, Pesi was confident that ultimately the need for the consumer to know the product he was buying would triumph. As recent amendments indicate this is actually materialising.

A keen supporter of globalisation, Pesi was convinced that it entailed giving up narrow sectoral and nationalistic concepts of sovereignty. He argued that when we could converge on standards of aviation, nutrition and environment what was so sacrosanct about accounting and auditing that we felt insecure about adopting international standards. Further, he prophesied that mere convergence of accounting would not work and would be a disaster if it was not accompanied by a convergence of interpretations, performance standards, and monitoring standards. In fact, counter intuitively he argued that convergence of knowledge standards - where highest quality of standards are known and practiced by professionals,- would not help, unless there was convergence of standards of understanding among the stakeholders and lay users.

Always a student, Pesi was a rank holder in the examinations of economics and law of Calcutta University in the 1940s and the English Institute of Chartered Accountants. At the age of eighty plus he took up and mastered IFRS, the new body of professional standards and in one of his last public appearances captivated the audience at a chamber of commerce with his technical insights thereon.

His prescience was legendary, in the 1980s he singled out a freshman speaker at a conference and said “you will go a long way in the profession”, 10 years later that person became the youngest in history to head a major accounting profession in the world. A person of strict discipline- he would complete reading all his daily papers, fold them and place them in the dustbin before half past ten in the morning, - on the August 8, he called his secretary of the past three decades in the morning and made her write down how he would like to divide some of his possessions among all his attendants and loyal helpers who had been with him over the years. At the end of this before he sat down to lunch, he said to her, “Anne, now I can die in peace”. He did so, — in the night, — after dinner.

This article appeared in the 01 September 2008 edition of Business Standard, which is available at this link.

Mainstreaming the accounting profession: Mindsets and mind blocks

With an institute that has grown to be the second largest in the world, the time has come when Indian Chartered Accountants (CA) can dominate the world stage like accounting professionals from no other country.

At an individual level the Indian CA has taken the world by storm. Indian CA professionals are as proficient in understanding and implementing International Accounting Standards (witness the outsourcing of accounting to India) as the best in the world.

For the world to witness and experience our potential as CAs, we need to speak the global language of common standards, common practices, common attitude and outlook. That said, it is in areas where regulatory enablement is required that we are woefully falling behind, preventing us from achieving our standing in the global accounting arena.

‘Made in India’ rules and guidelines are rising the walls of “country specificity” isolating the Indian profession, at a time when the profession should be out there conquering the world.

Regulators of the profession seem to think that all national and international laws and regulations must necessarily be amended to be made India-centric. As a result these laws end up shackling the profession in its bid to internationalise itself. Witness the recent proposed amendments to the CA Regulations.

In a welcome move the Government of India had in 2006 amended the CA Act to allow CAs to form multidisciplinary partnerships with non CAs. This has for long been a global norm, but was prohibited in India. The Institute of Chartered Accountants (ICAI) was given the power to propose the categories of individuals a CA may partner with. While the ICAI has taken the correct step of proposing partnering with lawyers, architects, actuaries, engineers, cost accountants and company secretaries; it has undone the drive for internationalising the profession by specifying that such engineers, architects, actuaries, lawyers e.t.c., must only be members of the relevant Indian professional body established under the respective governing Acts in India.

As a result, for example an Indian CA who wants to render cross border multidisciplinary services and bid for international contracts, would be ineligible under these regulations if he wants to tie up with professionals from those countries. However, most International Agency funded global contracts (like those funded by the Asian Development Bank, World Bank etc) stipulate partnering with a minimum number of domestic consultants.

Regulating quality of services delivered by Auditors is a matter of universal concern. The International Federation of Accountants (of which ICAI is a member) has issued for international usage a ‘Statement of Quality Control’ 1 (ISQC) laying down expectations from Regulators in this matter. The ICAI has modified this statement and issued an “Indian Version” for usage by Indian CAs. It is interesting to note the areas of modification.

The ISQC recognises that a variety of experts may possess the ability to evaluate the quality control processes in a firm while the Indian standard differs and says that only a member of the Indian Institute can evaluate the quality. Further, the ISQC recognises that other organisations that specialise in providing Quality control services would also be recognised as experts for evaluating the quality processes in a firm, a concept very relevant in today’s fascination with ISO certifications. In a stark contrast to this the ICAI says that only its own members can evaluate their own quality.

Imagine a simple case of providing cross border services of translating a set of financial statements to a foreign GAAP. The ICAI would have us believe that the person who can evaluate the quality of work pertaining to the Foreign legislation, (very often in a different language) could only be a member of the Indian institute. It is increasingly common nowadays to seek Assurance from an audit firm on matters other than audits and reviews of historical financial statements.

It is in these types of engagements that the profession is witnessing growth and for these assignments it is very critical to use non financial experts to ensure quality execution. With this significant amendment to the quality control standard, only a member of ICAI can vouch for the quality control in such areas. This goes against the very grain of multidisciplinary partnerships that the Government is trying to usher in.

The Public Companies Oversight Board (PCAOB) recently announced that all firms registered with it, including innumerable Indian firms, would need to declare and file annual reports of billings by the firm, percentage of billings from audits and names of clients on the PCAOB’s website. This would run totally counter to the advertising rules legislated by ICAI last month where disclosure of client names and billings by the firm would tantamount to advertising.

The time has come for us to abandon age old guidelines and liberalise the profession. Could there be any truth in the view that the Information Technology industry of India could go forth and conquer the world because it did not have any regulator? And the mandarins did not understand information technology well enough to raise the walls of India specific laws? Is there a lesson in here for the Accounting profession?

This article appeared in the 11 August 2008 edition of Business Standard, which is available at this link.

Advertisement ? thus far and no further?

Auditors and Advertisement? Even a few months ago this would have been blasphemy to most accountants. In the past, accounting professionals were not even allowed to advertise their existence as a professional, let alone the services rendered by him and this was strictly interpreted.

A case in example is that of an eminent past President of the Institute who was hauled up for severe disciplinary action, since the biographical notes of the author in the book he had written, mentioned that he was practising as a professional in his own name.

However, in a dramatic break from the prison of the past, the current young council of the Institute of Chartered Accountants (ICAI), in a landmark announcement this month, permitted Chartered Accountants to advertise and notified guidelines for this.

Prohibition of advertising was warranted in an age when the profession was small, the service offerings and capabilities were uniform throughout the profession and a CA was like a family general practitioner. With the profession's strength rapidly approaching the two lakh figure; portfolio of services and capabilities varying from firm to firm and clients seeking industry and subject matter specialism; not allowing advertising amounts to denial of the right to information to a consumer and curtails his freedom to make an informed choice. It also militates against the young professional who is unable to actively build his own brand as against already established brands.

However, all said and done accounting is a serious profession. Hence a permission to advertise cannot be a carte blanche for frivolity, flippancy, or misrepresentation. It should never ever raise false expectations – either from the profession or from the individual service provider. Hence it is understandable that the ICAI will tread cautiously. This seems evident in the guidelines, when in a relic from its regulatory past the ICAI has tried to prescribe the maximum font size as 14 for advertisements.

Where these guidelines fall significantly short of regulatory expectation worldwide is that these guidelines specifically prohibit disclosure of names of clients. Further, the guidelines would not enable a Chartered Accountant firm to disclose their total billing and specifically their fees from audit assignments.

This is directly in conflict with the requirements in force (e.g. EUs 8th Directive) and elsewhere which mandate that all firms of auditors must disclose in their public transparency report the names of all public interest entities that they audit as well as their total earning, indicating separately the amount of earnings from audits conducted by them.

This would lead to a situation where Indian audit firms would not be able to comply with these international requirements for transparency reports and thus would not be allowed to register in such jurisdictions. This would effectively disentitle Indian audit firms from conducting audits and issuing reports for Indian companies which are registered on Exchanges in Europe.

While advertising in the profession requires to be regulated, the broader question which one must keep in mind is that it is the ICAI's duty to ensure delivery of quality services; to ensure that firms invest in quality and expertise; to assure that professionals deliver quality services to clients, thereby uplifting the image of the profession at large. This has to be done by strongly investing in a robust system of quality review and inspection and taking visible action to enforce quality standards in the profession. This would be the greatest advertisement for the profession.

In today's time and place, it is not the duty of the ICAI to ensure equitable distribution of available work – the market place is competent to do that and work would find its own levels in the market place, based on different requirements of the consumer including price sensitivity, capability and the consumer's perception of the value that he is going to get from his service provider.

Accordingly, the Institute should believe in the maturity of the market and focus more on its critical role of maintaining quality. It's encouraging to see recent steps like the agreement in principle to permit Chartered Accountants to form multidisciplinary practices; relaxation in the advertisement guidelines and strengthening the peer review and financial report review systems. These are indication that the ICAI is moving in the right direction. But there is a much greater need for strengthening the pace of reform and fast forwarding the integration of the Indian profession with its global counterpart.

This article appeared in the 23 June 8 edition of Business Standard, which is available at this link.

A requiem for Schedule VI

The Ministry of Corporate Affairs (MCA), after the well deserved success of its flagship MCA-21 e-enablement project, is committed towards the simplification and transparency of corporate reporting.

As a step towards this, it is planning to revise and simplify Schedule-VI of the Companies Act which prescribes the presentation and disclosure requirements for financial statements. This simplification is a credible goal, particularly for companies which are not ‘public interest entities' as this would considerably remove costs and other associated impediments for small and medium businesses. However, time has come to ask whether the Schedule-VI format is relevant at all today?

Globally, professional bodies of accounting standard setters prescribe accounting formats. The advantages are obvious. This is a specialised area which requires professional input; and has to be updated frequently to keep pace with changes in the economic and commercial environment. A schedule to a law, which has to be debated and amended only by Parliament obviously does not offer the flexibility required. Also given the scheme of things, an accounting legislation may not be the highest priority of our Parliamentarians.

Today, the prescriptions of Schedule-VI are far removed from the reality of what financial statements mean. It is only a legal figment that accounts in India comply with Schedule-VI. For starters, Schedule-VI does not even have any prescribed format for a Profit & Loss Account; it does not require a cash flow statement; it does not require disclosure of accounting policies; it does not require disclosure for leases; it does not warrant disclosure of deferred taxes or disclosure regarding impairment losses or intangibles. Further, the Schedule VI was conceived in an era when nobody had even heard of derivatives and so remains blissfully unaware of derivatives and disclosure of potential losses therein.

On the other hand, the Schedule-VI requires detailed disclosure of inventories, capacity, production and turnover for every significant item produced or traded. This is not required under any global framework and is potentially disadvantageous for the Indian industry vis-à-vis its global competitors as it forces companies operating in India to disclose their confidential operating data. These disclosures were conceived in a "Licence Raj" era and serve no useful purpose today when alternate Segment Reporting data is already available.

Similarly, there is redundancy in data disclosures pertaining to dues from or transactions with, related parties (eg, companies under the same management, director/officers of the company etc.) where there is an existing parallel and more efficient framework of related party disclosures which is warranted by Accounting Standards and is globally acceptable. A lot of clutter such as requirement to disclose CIF values of imports, and earnings and expenditure in foreign currency continues to be mandated by the Schedule VI. These are essentially relics of the insecure foreign exchange days of the sixties and the seventies.

While on one hand the MCA is trying to reinvent the Schedule-VI, on the other hand multiplicity and confusion in the standard setting process in the country is increasing. ICAI's Accounting Standards Board is setting Standards; the National Advisory Committee of Accounting Standards (NACAS) is considering and notifying Standards; the MCA is notifying Rules (Accounting Standards Rules, 2000) that directly contradict Schedule-VI thereby creating a legislative conflict by specifying that a Rule will override an Act !!; the RBI is issuing provisioning & income recognition guidelines; SEBI is mandating presentation and disclosure formats of interim and annual results; and the ICAI is busy issuing ‘announcements', impacting accounting but without either the due diligent process of formulating Standards or investing these announcements with the authority of a mandatory pronouncement.

If the MCA really wants to move to an internationally comparable regime of accounting and transparency, it should not waste its resources in trying to write presentation and disclosure standards into laws. Rather it should repeal both the Schedule-VI to the Companies Act and the IIIrd Schedule of the Banking Regulation Act.

The MCA should invest in laying down rigorous laws around processes of standard setting, ensuring the independence and professionalisation of designated standards setters, unification of Accounting Standards within the country and harmonisation of standards internationally. It is time we all spoke same language. It is time we gave a decent farewell to Schedule-VI.

This article appeared in the 26 May 2008 edition of Business Standard, which is available at this link.

AS-30? A premature birth

In an environment where usage of complex and hybrid financial instruments is increasingly becoming common; where innocuous sale, purchase and rental transactions might conceal hidden derivatives; where sophisticated instruments have been made available to Indian Corporates; India could not afford to exist without Accounting Standards which prescribe measurement, accounting, presentation and disclosure norms for these instruments.

In these days and age, it is heretical to assume that significant commitments, potential liabilities or assets can stay off the balance sheet of any corporate. Therefore, the time for Accounting Standard (AS) -30 had come, a standard which deals with Recognition and Measurement of financial instruments was introduced out of necessity.

However, to enable AS-30 to become mandatory there need to be certain far reaching changes enacted. Firstly, AS-30 would have to be made mandatory by the Institute of Charted Accountants in India and notified by the National Advisory Committee on Accounting Standards (NACAS) for it to be legally recognised under the Companies Act. It is imperative to make AS-30 mandatory along with AS-31 and AS-32 which govern presentation and disclosure of all the AS-30 measures.

AS-30 scopes out substantial provisions relating to insurance contracts and refers throughout to the “Accounting Standard on Insurance”. Ironically, this Accounting Standard is yet to be formulated. AS-30 pivots around the concept of fair valuation which implies taking into account at every balance sheet date fair value gains and losses.

This contradicts the conservatism enshrined in the concept of prudence under AS-1 which would not allow unrealised gains to be recognised. Further, fair valuation depth of valuers in the market coupled with trained and experienced advisors and auditors for corporates. AS–30 conflicts with several provisions of at least eight other mandatory Accounting Standards, which would all have to be amended.

As on date, not a single of the conditions in the preceding paragraphs has been complied and there is a bleak likelihood of it happening in the next two years. ICAI’s landmark announcement on March 29, 2008 has prematurely delivered AS-30 to the world.

If one takes a legal microscope on ICAI’s announcement, apart from the prima facie inappropriate drafting, it would not hold ground owing to internal contradictions and a dozen issues legal pundits could raise with it.

The announcement was not intended to be a legal document and it would perhaps be unfair to view it as such.
The spirit of the announcement is that “it is not prudent to sit on unprovided potential losses and so if there are such unprovided losses, it should be provided”. The announcement identifies that AS-30 provides a strong basis for recognising, in a fair manner, the likely impact of losses from unsettled derivatives (among other matters).

Therefore where AS-30 is followed, no separate accounting is required to be undertaken for a prudential provision of existing losses.

That said, the problem with this simplistic assumption is that AS-30 could account for fair value gains, while those following ‘Prudence’, will not be able to. Those following AS-30 can take benefit of transitionary provisions and account for past losses directly to reserves, but those following the announcement would have to book all losses in the P&L account in the quarter ended March, 2008 itself.

Further, those adopting AS-30 would not be able to implement hedge accounting, accounting for investment or inventories or forward contracts as required by AS-30 as they would risk violating other unamended contradictory provisions of various Accounting Standards, In addition, there will be significant tax consequences because of several unanswered questions such as would gains/losses on adopting be regarded as notional or real; would they be taxable/deductible. There are no specific provisions in tax laws, no judicial precedents.

Thus, unwittingly the announcement introduces AS-30 into a hostile environment where none of the enabling and supporting legislations are in place.

Whether AS-30 would be able to survive in this environment, is a great concern; whether uninitiated implementers, preparers and fair valuers would mongrelize AS-30 leading to the international community disowning the Indian version of accounting for financial instrument, is a nightmare, many of us have to live with in the short term.

Let us hope that the authorities ICAI, RBI, SEBI and CBDT realise the gravity of the situation and come together and commence a well thought out and drafted legislation and clarification. The sooner, the better.

This article appeared in the 21 April 2008 edition of Business Standard, which is available at this link.

There is an urgent need to converge accounting standards

During a conversation a decade ago with a senior regulator on the prevalence and acceptance of qualified audit reports in India, the regulator remarked “Why would a qualified audit report be considered undesirable? I would have thought a ‘qualified’ audit report would mean that the audit report or the auditee had some additional attributes, just like we speak of a ‘qualified person’. This one incident etched in my mind all that bedevils India when it comes to stakeholder’s understanding of an audit report or placing confidence thereon.

Globally, audit reports are unqualified, meaning that the auditor would without any reservation express his confidence on fairness of the financial statements. Issuance of a qualified opinion, globally, is in the rarest of rare scenarios only. However, in India, convention, practice, and business usages have combined in a manner in which a ‘qualified audit opinion’ is an extremely common occurrence.

A number of these qualifications arise because the auditor wants to play safe since the past history of regulatory action does not provide confidence of regulators appreciating the ‘materiality’ aspects of reporting. While Audit works on a framework of designing processes and finally reporting results based on materiality thresholds which are linked to the size of the entity and its results, regulators and external reviewers in India tend to stray far from such a materiality driven approach.

When confronted with an aberration which in absolute terms may look quite big but in relative materiality quite insignificant, auditors and regulators tend to give more importance to the absolute size of the item and not its relative insignificance. This is one major reason why qualifications clutter up Indian audit reports. Another type of qualification pertains to wrong or impermissible accounting. These are commonly expressed in phrases like “such and such has been accounted for in so and so manner, which is not in accordance with the Accounting Standards ‘X’ issued by ICAI,…subject to our observations, the accounts give……true and fair view…”. This is unacceptable from a global point of view.

The SEC in the United States does not accept a qualified audit report under the Securities Act of 1933. As a result, all listed entities in the United States have to necessarily correct their accounts for any qualification. However, in India we go to the other extreme where a qualification is considered to be so routine that a few years back the Companies Act was amended to require that all qualificatory comments should be separately printed in italics so as to draw the reader’s attention!

Though, the Indian Auditing Standard on reporting is modelled after the relevant International Standard, its actual implementation is quite different in India. Three points of significant difference comprise — a) the tendency to qualify immaterial items, b) the tendency to simply qualified items which in aggregate or individually would be material and in most other jurisdictions would end up in a ‘not true and fair’ opinion, and c) increasing usage of the “Matter of Emphasis” option whereby an auditor merely draws the attention of the reader to some uncertainty without qualifying his opinion. There is a possibility of this being used in cases like provisioning for disputed claims and debts, where in most jurisdictions the auditors would be expected to make a judgment call and quantify under provision.

These accepted practices of audit reporting, along with India’s unique GAAS provision relating to responsibilities of Joint Auditors — where though all the auditors sign the same set of financials, each is only responsible for the work done by himself and is not responsible for the work done by the other auditors which is contradictory to the “joint and several” responsibility concept of auditors elsewhere in the world — significantly impacts the credibility of Indian audit reports.

What is the way out? A simple answer is to require that the accounts of all Public Interest Entities would have to be restated to ensure that they are free from audit qualifications/scope limitations/matters of emphasis, disclaimers and negative comments. As an intermediary step, Corporate Law may be amended to ensure that dividend distribution can only be made out of available surplus after adjusting the impact of all audit qualifications.

While we are working towards converging with International Accounting Standards, the goal of convergence and global acceptance cannot be achieved if we do not also simultaneously converge our Auditing Standards and practices.

This article appeared in the 24 March 2008 edition of Business Standard, which is available at this link.

In search of a greater assurance

As the global economy gets more complex, groups and entities across political geographies require optimising their structural efficiency owing to numerous different regulatory and tax jurisdictions.

Financial instruments are becoming more complex, intangibles and derivatives are assuming central roles in the resultant tangle and even finance professionals are often at a loss to read and correctly interpret entity financials or forward-looking statements. The lay investor is obviously at sea.

In this maze there is an increasing demand by stakeholders for a greater transparency and assurance around financial statements. There is a growing realisation that such assurance can only be obtained by rigorous examination and certification of these accounts by a service provider whom investors can rely upon.

In this quest for greater assurance, it is inevitable that there would be concerns about the competence and integrity of the assurance provider. Both these attributes require equal emphasis.

However, in some jurisdictions like India, there is an obsession with visible and presumed indicators of ‘integrity’, very often, to the total neglect of ‘competence’. This attitude is counter productive and possibly stems from a deep-seated paranoia about collusion between management and auditors. It reflects a sub-conscious distrust of the ability of regulators to detect such collusion.

Some proponents of audit quality argue that rotation of auditors, joint audits and centralised agency-driven audit appointments are a panacea. However, most of the major instances of alleged audit inadequacies in India have traditionally happened in sectors like the banking sector, where rotation, joint audits and centralised appointments, are simultaneously practiced!

Competency-based profiling of audit firms are discouraged and archaic advertisement rules prohibit firms from showcasing their competencies. Prospective users of an audit firm’s services are thus denied full knowledge of comparative strengths, weaknesses and delivery capabilities of different firms.

Thus, the process of choosing a service provider either becomes very tedious or fall backs to a default mechanism of personal knowledge and proximity to a particular audit firm.

Effective auditing depends on an auditor’s ability to develop a detailed understanding of the auditee’s complex structures and operation. Research conducted by the American Institute of Certified Public Accountants (AICPA) in the USA, of over 400 cases of alleged audit failure, indicated that in 75 per cent cases, the auditor was performing his first or second audit of the company.

This correlates with the Bocconi Report findings that in the first year of an audit, 40 per cent more audit hours are required; audit costs are greater by 15 to 25 per cent and training period for new auditors of complex groups appear to be 2 to 3 years. Very often, in industries such as banking, insurance, telecom, sector specific knowledge is a must.

Rotation destroys the knowledge an auditor develops on specific matters related to an entity. This ultimately leads to audit firms not investing adequately in industry specialism because dis-economies of rotation or cap on number of audits do not make it feasible to do so.

In fact, any un-ethical promoter group would always encourage rotation of auditors since that would ensure that the auditors are on the learning curve continuously.

Further, these companies would even prefer a practice of joint and multiple auditors and carve out different domains of complex transactions between different auditors so that no one gets the full picture.

In addition, there is also the option to levy a cap on all other types of non-audit activities so that the auditor knows less about the detailed workings of an entity. In India, they could easily do all these with the misplaced blessings of the regulators!

For greater assurance we require a paradigm shift. Auditors' integrity should be taken for granted, but needs to be reinforced by a strong and effective system of peer review; stringent and expeditious follow up of disciplinary cases; streamlining the disciplinary provisions by eliminating outdated requirements relating to deemed advertisements and eliminating permissions required by a chartered accountant for various activities such as teaching; writing articles; participating in professional sports or growing agricultural products! We need to concentrate on fast-track decisions; wide publicity to exemplary sanctions and professional misconduct and gross negligence cases.

This article appeared in the 28 January 2008 edition of Business Standard, which is available at this link.