Tuesday, August 05, 2008

Sleight of hand or indifference?

Ah, well there you have it. Companies reporting financial results in ways as are most convenient.
Under the Indian laws, Companies prepare accounts for two different purposes under two different set of regulations. The one under Schedule VI of the Companies Act, 1956 for statutory purposes and shareholder review. Another is in compliance of the Income Tax Act, 1961 that is recognized by the Income Tax authorities. While the former lays emphasis on disclosure and shareholder information, the latter stresses on revenue recognition and tax compliance. Often there are divergences between the two because of which the financial results are often at a variance.

For example, Schedule VI of the Companies Act permitted companies to adjust the exchange gain/loss to the cost of fixed asset. So if a company bought a fixed asset for $10 (Rs 400) with a forex loan and suffered an exchange loss of say Rs 30, it could add this loss to the cost of the fixed cost (Rs 400 + 30). They get to claim depreciation (read tax savings) on that inflated cost of the asset as well.

And then there is the accounting standards prescribed by ICAI that falls somewhere between the two. ICAI AS-11 calls for recognition of this loss of Rs.30 by charging it to P&L account without adjusting the actual cost of the asset (which is eligible for depreciation). The existing treatment allowed companies that had foreign currency borrowing for acquisition of assets to inflate their assets position on account of adjustment of exchange differences every year. The companies that did not resort to foreign currency borrowing for acquisition of assets had a disadvantage as they were required to write off their financing cost in the profit and loss account.
As of now, the first-quarter results of several big companies such as Reliance Industries, Reliance Communications, Bharti Airtel and Jet Airways would have been a lot worse had they followed the Accounting Standards (AS) 11 rules prescribed by the Institute of Chartered Accountants of India (ICAI).

Even under the International Accounting Standards (IAS), Prior to the 2003 revision of IAS 21, an exchange loss on foreign currency debt used to finance the acquisition of an asset could be added to the carrying amount of the asset if the loss resulted from a severe devaluation of a currency against which there was no practical means of hedging. That option was eliminated in the 2003 revision. ICAI too followed suit in 2003.

But reading that news item gave me scope to laugh a lot. The excuses of Reliance Industries, Bharti, Jet, sound so flimsy. Most of them have taken refuge under legal opinions (many retired judges depend on it for their livelihood) that are available for a price. Reliance Communication chose not to respond. When you are living in denial and trying to fool yourself, silence is the best option.

Or is it indifference?

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