AS 28

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					Compliance with Accounting

Akhil Bansal
27 July 2007
Measurement Science

Test each accounting principle for its capacity for measuring
and disclosing

  Wealth:            Net worth, net assets, assets and

  Performance:       Inputs, outputs, expenses, income

  Liquidity:         Cash inflows, outflows from
                     operations, financing and investment
Reporting framework evolves over time

 Stages of economic growth
 Globalisation efforts
 Corporate ethics
 Institutionalisation of capital markets
 Stakeholders’ expectations
The US experience

   Macro developments trigger reporting advances
Similar experiences across continents

 United Kingdom
     Accounting standards introduced in 1972
     Kept pace with developments in the US
     Independent standards formed in 1983, earlier worked on IASC
     Stepped up pace with others, now equivalent to US GAAP and IAS
 Reporting standards in other developed countries
     Created around same time as FASB
     Kept pace with each other learning from each others mistakes
     IASB (International Accounting Standards Board)
         Formed in 1973 in agreement with accounting bodies of 10 developed countries
         Worked in conjunction with FASB in forming various accounting standards
India – The story so far

 No longer isolated
 Commendable progress in recent years
    Economic reforms
    Competitive pressure
    Learning from each others’ mistakes
    Corporate misconduct
 Competing for global capital
 Capital markets becoming institutionalised
 Several new standards during last few years
ICAI - Big leap in financial reporting

                            Before 2000   In and after 2000    Total

Accounting Standards (AS)          15            14            29*

Auditing and Assurance             17            18            35*
Accounting Standards                             30             30

* Revisions
Accounting standards                              2
Auditing and Assurance Standards                  3

         Indian GAAP is being modified on a continuous basis
Rationale behind Accounting Standards

 Measurements are within a conceptual framework which
 emphasises prudence, going concern, cost (not current
 value), accrual, substance over form, consistency and

 Test each auditing issue for its capacity for adding
 credibility to given propositions/assertions
Mandatory documents on accounting

 The standards describe the
  ─   accounting principles and
  ─   methods of applying these principles in the preparation and
      presentation of financial statements
  so that they give a true and fair view

The standards are applicable to general purpose financial statements
and other financial reporting, subject to attest function, issued by      Applicability
  – corporate or co-operative or non-corporate

 –    commercial, industrial or business enterprises whether profit oriented or not
 –    charitable or religious organisations, if any proportion (howsoever small) of
      their activities is commercial, industrial or business in nature
 –    financial statements prepared on cash basis

 In the event of any deviation from a mandatory standard the auditor
 is required to make adequate disclosure in his report                     Reporting
 Auditor’s duty in relation to a mandatory
 accounting standard in case of companies
                                Ascertain accounting policy followed
                                and disclosure made by the enterprise

        No              Is accounting                          Is disclosure as       No
                         policy as per                          per standard?
                                                                                   Make negative statement
Make negative                    Yes        Make positive      Yes                  under section 227(3)(d)
statement under                            statement under
section 227(3)(d)                          section 227(3)(d)
                                                                Yes                       Is there a
                                                                                       violation of legal

         Is effect of               Yes                                      Yes
          deviation                           Qualify the audit report                 Is true and fair
          material?                                                                     view affected?
                                    No                                        No
                                             No further action required

 While management may consider materiality in the preparation of
 the financial statements and MD&A, it is generally inappropriate
 to permit known errors to remain in the financial information
 based merely on their immateriality

 Both quantitative and qualitative factors should be evaluated
 when assessing the materiality of misstatements, focusing on:

    Individual and aggregate misstatements and their impact on
    key financial statement line items, totals, and ratios

    Whether    a    misstatement   increases   management’s
    compensation by satisfying requirements for the award of
    bonuses or other incentives

    Whether a misstatement masks a change in earnings or other
    trends or hides a failure to meet analysts’ consensus

    A misstatement’s impact on compliance with financial
    statement-related debt covenants

    A misstatement indicative of intentionally misleading financial
    reporting or illegal acts

    A misstatement particularly important to a segment of the
Standard setting

 ICAI took up the task of laying down accounting standards in 1977

    accounting standards issued by the ICAI were however
    mandatory only for its members

 Companies (Amendment) Act, 1999 gave recognition to
 accounting standards thereby making it mandatory for companies

    Standards to be formulated by ASB/ICAI Council

    Standards to be prescribed by the Central Government in
    consultation with the National Advisory Committee on
    Accounting Standards (NACAS)

                   REQUIREMENT !!
Companies (Accounting Standards) Rules, 2006

Central Government, in consultation with NACAS, has issued the
Companies (Accounting Standards) Rules, 2006 notifying
accounting standards 1-7 and 9-29, effective for COMPANIES for
accounting periods commencing on or after 7 December 2006

  For annual accounts for
                               ICAI standards would remain
  period ending 31
                                 applicable even in case of
  December 2006 or 31
  March 2007

      The Notified standards by and large follow the ICAI
      standards except for certain differences

       ICAI                           RULES

ICAI          classifies The Rules stipulate only two
enterprises into three categories –
categories                (i) Small and Medium Sized Company
                              (SMC) which is entitled to certain
  Level I (large),
                              exemptions and
  Level II (medium) (ii) other companies
   and                                       Unlike ICAI, no
  Level III (small)                       distinction between
                                            small and medium
  The prescribed standards are mandatory for all companies
              except as exempted/relaxed for SMCs.
Relaxations/Exemptions available to SMCs

 Full exemption               AS 3, Cash flow    AS 17, Segment
                                statements         reporting


 AS 20, Earnings per      AS 28, Impairment
        share                  of assets
    AS 29, Provisions,
 contingent liabilities and      AS 19, Leases
    contingent assets
Issues to be resolved

      What happens if ICAI revises an accounting
 ?    standard?
It seems that till such time that the central government
prescribes the revised standard, companies would be
required to continue to apply the notified (i.e. pre-revised)

       What standards are applicable to enterprises
 ?     other than companies?

ICAI’s existing standards, unless ICAI decides to announce
that such enterprises should also follow Government notified
Issues to be resolved

      What happens if ICAI issues an accounting
?     standard on a topic not covered by any of the
      notified accounting standards?

The prudent view would be that until an accounting standard
on a new topic issued by ICAI is prescribed by the Central
Government, it will be deemed to be an accounting standard
The four “AXIOMS”

 Incomplete information creates UNCERTAINTY

 Uncertainty creates RISK for Investors & Creditors

 Risk makes investors & creditors demand a higher Rate of Return

 Higher ROR means higher cost of capital for the company and
 produces LOWER market values of company’s securities
Quality financial reporting

 More complete information that will reduce uncertainty
 Less uncertainty will reduce risk for investors and
 Reduced risk makes investors and creditors satisfied
 with a lower Rate of Return (“ROR”)
 Lower “ROR” means lower “cost of capital” for the
 company which produces higher stock market values
Peer review norms for auditors of listed

 Peer review - A system introduced by the ICAI few years
 back whereby professional practices/procedures and
 attestation records of auditor are examined by another
 professional of similar standing appointed by ICAI

 Following suggestion from SEBI, ICAI has now enlarged the
 scope to cover all firms conducting audit of listed
 companies to undergo peer review once in three years
Who audits the auditor?

                                                   Effective for auditing firms
                                                        from 1 April 2003

                                                         One of international best
          Peer Review
                                                      Mooted in the backdrop of
                                                      Enron disaster which led to
                                                    investors losing confidence in
                                                          auditing practices

An examination and review of the systems and procedures of the PU to determine
 – whether they have been put in place for ensuring the quality of attestation
   services as envisaged and implied/mandated by the Technical Standards
 – whether these were effective or not during the period under review
 Quality Review Board (QRB)

Constituted by Central Government comprising the chairperson
as well as 5 members nominated by Government and another 5
nominated by Council
  Recommendations to the Council for quality of services
  Review the quality of services (including audit services)
  Guide members to improve the quality of services and
  adherence to the various statutory and other regulatory
Financial Reporting Review Board (FRRB)

              ICAI constituted FRRB in 2002
 FRRB         Panel to be a sub-group within the Central Council but
               may form a part of QRB once the new law is implemented


  To review compliance with accounting and auditing standards
  In the long-run, improve overall quality of works of members
  Reviews restricted to published general-purpose financial statements

  Reviews by FRRB would not be verification of the entire audit (re-
    audit) or review of working papers of the auditors
Financial Reporting Review Board (FRRB)

             Compliance with generally accepted accounting principles
             Compliance with disclosure requirements prescribed by regulatory
              bodies, statutes and rules and regulations
             Compliance with reporting obligations of enterprise and auditor

                    Enterprises whose debt or equity securities are listed on a
Enterprises          recognised stock exchange in India
                    Public financial institutions and banks

                    Non-listed and other commercial enterprises having a
                     turnover of Rs. 50 crores or more

                    Such other category of enterprises which in the opinion of the
                     Board make the public interest vulnerable due to
                     susceptibility to non-compliance
  Financial Reporting Review Board (FRRB)

                  Either suo motu or on a reference made to it by any regulatory body
Selection of
enterprises       Enterprises relating to which serious accounting irregularities in the
                   general-purpose financial statements have been highlighted by the
                   media reports

               Implications of findings

                  Auditor: Findings of the panel to form an input for disciplinary
                   action committee to punish members found to be grossly negligent
 of findings
                  Company: Pending grant of relevant powers by Government,
                   communicate the irregularity to the relevant regulatory body and
                   company’s management
Serious Fraud Investigation Office (SFIO)

 Multi-disciplinary office set up under the Department of
 Company Affairs

 Objectives include detecting and prosecuting or
 recommending for prosecution white collar crimes/frauds

 Take up cases of fraud suo motu and refer to relevant
 departments for investigation

 Constitution – 12 senior officers from SEBI, IT department,
 RBI, CLB, nationalised banks and chartered accountants
 Serious Fraud Investigation Office (SFIO)

      Cases investigated by SFIO are characterised by

Complexity and      Substantial involvement     Possibility of
having     inter-   of public interest to be    investigation leading to
departmental        judged by size, either in   or contributing towards
and        multi-   terms of monetary           a clear improvement in
disciplinary        misappropriation or in      systems, laws and
ramifications       terms of persons affected   procedures
Six key issues “that underlie the financial
reporting reform debate”
 MULTIPLE STAKEHOLDERS - can business reporting satisfy needs of all

 DECISION MAKING - how far are investors and other stakeholders
 dependent on formal business reporting

  THE “INVISIBLE HAND” - markets will reward good disclosures and
 punish bad. Thus market incentives and not regulation will lead to better

 CONCEPTUAL FRAMEWORKS - existing frameworks are limited to
 historical financial data – they need to be broadened

 INTANGIBLES - by emphasising only those on which cost has been
 incurred has financial reporting missed the significance of valuable
 “intangibles” like human resources, self developed technology

 TRANSPARENCY - all stakeholders will benefit from greater openness
Focus areas for the future

 Strengthen quality of reports : MD&A, Corporate
 Follow the thought leaders
    Value reporting
    Sustainability reporting
    Corporate Governance ratings
 Adoption of IFRS –yet another challenge !
Adopting international accounting standards
in India

          ICAI has recently decided to fully converge with
          IFRSs from accounting periods commencing on or
          after 1 April 2011

 IFRSs so adopted would apply only to listed and other public
 interest entities as defined (such as banks, insurance
 companies and large sized entities)

 Instead of prescribing exemptions/relaxations in full IFRS or
 existing Indian accounting standards, convergence by SMEs in
 India will be achieved by applying the proposed IFRS for SMEs
 (with or without modifications)
Why is Harmonization Necessary?

 To facilitate cross-border economic relationships –
 trade, commerce, movement of capital – accounting,
 which is the language of business, needs to be made
Is it possible to have convergence?

 Accounting measurements take place in a dynamic world
 with different environments

   Legislative environment       Political thought

   Social environment            Nature, size and complexity
                                 of business enterprises
   Degree of centralisation in
   the economy                   Nature & size of capital
   Stage    of      economic
   development/inflation         Stability of currency

 Around 102 countries permit or require the use of IFRSs by
 some or all of their domestic listed companies or have
 announced plans to do so
Challenges in India in respect of
convergence with IFRS

 Legal and Regulatory Constraints
   Schedule VI
   Proposed Dividend
   Preference share capital
      Consolidated Financial Statements - not regarded as
      general purpose financial statements for various
      purposes, such as dividend, taxation etc.
Challenges in India in respect of
convergence with IFRS (contd.)

 Stage of Economic Development
   Depth and breadth of capital market
   Non-availability of reliable fair values
 Frequent revisions to IFRS
   In some cases, revisions to IFRS are made/proposed
   within very short period of their issuance, e.g., IAS 39,
   IFRS 3
   Results in delay in formulation/revision of corresponding
   Indian AS
Thank you
You're a successful Partner in a large professional
services firm. You are busy, more than you'd like to be,
but otherwise life is good. Until...

You open the paper one morning and discover a key
client is in serious financial difficulty. It's a surprise, but
doesn't cause you immediate panic. A few days later…

Your firm's name appears in articles relating to the
failure The implication is that your firm fell asleep on
the job and suddenly your Senior Partner has an
unusually strong interest in talking to you. Soon after
you are called for a meeting with your firm’s legal
counsel. Your confidence is evaporating….

Six months pass and the legal claims are flying. Your
regulatory body is investigating your involvement. Your
other work is suffering. Your profit shares are falling
faster than your reputation……

       Welcome to the beginning of the next few years of litigation!
Compliance with accounting
  standards - move towards
transparency and challenges
Transformation challenges

 The issues of transparency, accounting practices and
 corporate governance have come to the fore as high
 agenda items in organisations worldwide

 Equity and debt markets have become less forgiving

 Complexity and sophistication of business structures and
 transactions has increased

 Complex and voluminous standards - the pace of change in
 areas of accounting, auditing and corporate laws has also
 increased to catch up with the developed world

 Management is under performance pressures
Transformation challenges

 Expectations of investors and regulators are changing
   Greater assurance
   Zero tolerance for errors
   Desire   for   enhanced       results   and    improved
   More oversight
   Clear evidence of internal controls
 Society is increasingly becoming more demanding on
 issues relating to financial reporting and corporate
Financial reporting

 Reliable and transparent financial reporting is particularly
 important in an evolving business environment and is also
 fundamental to the well-being of capital markets
 Though financial reporting cannot forecast the strengths
 and weaknesses of the economy, the financial statements
 and related information MD&A can provide useful
 information that allows users to make informed decisions
 and facilitates continued efficient functioning of capital
 Definitive actions are needed by a range of parties to
 address legitimate concerns, better protect the public
 interest, and restore investor confidence
A new reporting relationship

 Management, auditors and audit committees each has
 a separate role and responsibilities


 The goal must be the same

When the numbers don’t add up…

  Defer revenue expenses in one year & write them off against the
                      reserves in the future

                     Go in for big bath accounting

               Book inter divisional sales as revenue

            Use deferred tax sales tax as part of income

                  Show one-time gains as operating income
 Learning from experience

  Document conclusions
                                          Review whether
      especially on
                                            changes in
    subjective matters
                                            policies and
                                           estimates are
   Ensure                                 not for earnings
adequate and                               management
                           Lessons from
 appropriate                 the past

                                          Consider the
  Accounting policies                     impact of non –
 should be worded as                      compliance, if
 closely as possible to                   any, with laws
the text of the standard                  and regulations