The discovery that many large companies are using a contradiction between two sets of rules (one on accounting standards, and another provided under company law) to improve the profits that they report, should come as a wake-up call to all those who believe that India now has good governance standards in companies. The clear intention of the companies which have parked foreign exchange losses on capital assets in the balance sheet, without booking them in the profit and loss account, is to boost the bottom line — in some cases, by substantial margins (as reported in this newspaper yesterday). All the companies involved have quoted legal opinion in their favour, and therefore have provided themselves with some cover for their actions. The question, though, is what is the correct thing to do, not what might pass muster in a legal dispute. And it seems clear enough that these losses should be booked in the profit and loss account. That is what India’s accounting standards ask you to do. That is what the US accounting standards ask you to do. And that is what the international accounting standards ask you to do.
The fact that there is a loophole provided in company law is not a good explanation for ignoring the relevant accounting norm. Indeed, the accounting standard in question was issued by the same department of corporate affairs that is responsible for giving effect to company law, and it issued these standards as recently as in late 2006. Indeed, the department specifically said when notifying the accounting standard, in a footnote: “It may be noted that the accounting treatment of exchange differences contained in this Standard is required to be followed irrespective of the relevant provisions of Schedule VI to the Companies Act, 1956.” When the authority that oversees company law is itself saying that the accounting standard over-rides the relevant provision in company law, there should be no ambiguity on what is the right thing to do.
In less than three years from now, in April 2011, India will have to comply with the International Financial Reporting Standards (IFRS), which have been issued by the International Accounting Standards Board (IASB); no fewer than 125 countries have already agreed to adopt these standards. There are 41 IFR standards so far, only two of which are the same as those followed in India. Adopting another 10 will need changes in company law, among other laws, and 29 will need changes in the standards currently prescribed by the Institute of Chartered Accountants of India. For instance, the Companies Act prescribes a fixed rate of depreciation for different categories of machinery and equipment — IFRS, however, says that depreciation should be based on an evaluation of the useful life of the machinery. The Companies Act, similarly, lists preference capital as equity while the IFRS says it is debt. Since this will affect the debt-equity and other financial ratios, it is clear that banking sector norms will also undergo a change. Similarly, the rules for how future liabilities are to be treated are different. The list goes on — a company needs to have five years of financial data for an IPO, but if all data are to be prepared under different rules, how will the stock market regulator deal with applications for public share issues? On the face of it, changing the Companies Act or other legislation that runs counter to IFRS is easy, but in practice, such legislative activity could take years. Given how companies are using the different provisions in existence today, all the relevant provisions of law and rules need to be aligned without delay.
