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.