Ladies and Gentlemen: It is a great honour for me to present to you a brief on International Accounting Standards. Since the days when I was studying for my accountancy exams, the complexity of the accountancy world has greatly increased. The explosion in financial innovation, in regulation, and in an ever increasing range of complex financial instruments has made things much tougher. But hopefully the increased complexity has made our qualification more valuable, and the careers it equips us to embark upon more rewarding and interesting too.
You are familiar no doubt with the well worn jokes about accountants. I am not going to tell any.
But I am certainly happier to have qualified as an accountant than I think I would be if I had qualified as an economist. I don’t know why I veered towards accountancy rather than economics. Maybe because I could never see value in working for a qualification that would equip me to tell people tomorrow why the things I predicted yesterday didn’t happen today. Although having gone into management subsequently, I did come to realize the value of being able to explain why the things that were promised the day before couldn’t be delivered the day after it.
I am very conscious of the crucial importance of international cooperation between all key players – those involved in regulation, in supervision, in the oversight bodies and in the profession itself. The world economy and the world’s capital markets are more interwoven and inter-dependant than ever. That’s why it’s important that we all pull in the same direction.
Global growth has been impressive over most of the past 15 years. Corporate performance has greatly improved. This is in part thanks to more incentive-based remuneration structures- especially share options. They have provided a greater stimulus to management teams to deliver shareholder value. But there has been downside to those remuneration structures too. In some instances they seem to have enhanced the temptation and therefore the risk of account manipulation and led to corporate scandals. These scandals do untold damage – way beyond their immediately obvious impact...
They undermine the trust which must at all times be at the heart of financial markets. A small number of high profile misdemeanors – in industry and in the accountancy profession (Arthur Anderson) itself- have long term, lasting consequences. The incremental risk premium this gives rise to for investors get priced in to a higher cost of capital for companies.
One of the lasting consequences of the scandals of recent years has been the destruction of one global accountancy business, and a substantial increase in the regulatory burdens and risks for others. The higher professional indemnity insurance costs and higher audit fees that have inevitably followed get passed on to the end-client and then the consumer. Inevitably they also result in directors- executive and non-executive – seeking higher remuneration to compensate for the heightened risks and more onerous regulatory responsibilities that they now face.
I worry that there is a real danger that the downside risks now facing non-executive directors will deter talented and experienced people from sitting on boards and providing their experience and wisdom. There will be no winners from that. The challenge that regulators face is to tackle mal-practice and lack of transparency without stifling the economy and laying down unnecessary red tape for entrepreneurs. Accounting standards and appropriate disclosure are complex issues, and achieving proper and useful disclosure is not an easy task. Disclosure is not just a greater volume of information but information provided in context. Companies need to make disclosures in a way that promotes and encourages transparency. In the long run, useful disclosures will benefit well-managed companies by allowing these firms to gain access to funds in the marketplace at rates that reflect their sound management. Of course, investors cannot be left completely off the hook--a point too often ignored. Analysts and stakeholders have an obligation to carefully analyze disclosed information and demand better disclosure if what is provided is not adequate or useful.
I will start this presentation with a peep into the Indian scenario and then proceed towards convergence and harmonization issues.
ACCOUNTING STANDARDS – INDIAN SCENARIO
The paradigm shift in the economic environment in India during last few years has led to increasing attention being devoted to accounting standards as a means towards ensuring potent and transparent financial reporting by corporates. Further, cross-border raising of huge amounts of capital has also generated considerable interest in the generally accepted accounting principles in advanced countries such as USA. Recent initiatives taken by International Organization Securities Commission (IOSCO) towards propagating International Financial Reporting Standards (IFRSs)/
International Accounting Standards (IASs), issued by the International Accounting Standards Committee, as the uniform language of business to protect the interests of international investors have brought into focus the FRSs/IASs. The Institute of Chartered Accountants of India, being the premier accounting body in the country, took upon itself the leadership role by establishing Accounting Standards Board, more than twenty five years back, to fall in line with the international and national expectations. Today, accounting standards issued by the Institute have come a long way. Presented hereinafter are some salient features of the accounting standard setting endeavors in India.
Rationale of Accounting Standards
Accounting Standards are formulated with a view to harmonize different
accounting policies and practices in use in a country. The objective of Accounting Standards is, therefore, to reduce the accounting alternatives in the preparation of financial statements within the bounds of rationality, thereby ensuring comparability of financial statements of different enterprises with a view to provide meaningful information to various users of financial statements to enable them to make informed economic decisions.
International Harmonization of Accounting Standards
Recognizing the need for international harmonization of accounting standards, in 1973, the International Accounting Standards Committee (IASC) was established.
The IASC has been restructured as International Accounting Standards Board (IASB). The objectives of IASC include promotion of the International Accounting Standards for worldwide acceptance and observance so that the accounting standards in different countries are harmonized. In recent years, need for international harmonization of Accounting Standards followed in different countries has grown considerably as the cross-border transfers of capital are becoming increasingly common.
Accounting Standards-setting in India
The Institute of Chartered Accountants of India (ICAI) being a member body of the then IASC, constituted the Accounting Standards Board (ASB) on 21st April, 1977, with a view to harmonize the diverse accounting policies and practices in use in India. After the avowed adoption of liberalization and globalization as the corner stones of Indian economic policies in early ‘90s, the Accounting Standards have increasingly assumed importance. While formulating accounting standards, the ASB takes into consideration the applicable laws, customs, usages and business environment prevailing in the country. The ASB also gives due consideration to International Financial Reporting Standards/International Accounting Standards issued by IASB and tries to integrate them, to the extent possible, in the light of conditions and practices prevailing in India.
Although the Accounting Standards Board is a body constituted by the Council of the Institute of Chartered Accountants of India, it is independent in the formulation of accounting standards since in case the Council considers it necessary that certain modifications be made in the draft accounting standards formulated by the ASB, it can only be done in consultation with the ASB.
Composition of the Accounting Standards Board
The composition of the ASB is broad-based with a view to ensuring participation of all interest-groups in the standard-setting process. These interest groups include industry, representatives of various departments of government and regulatory authorities, financial institutions and academic and professional bodies. Industry is represented on the ASB by their apex level associations, viz., Associated Chambers of Commerce (ASSOCHAM), Federation of Indian Chambers of Commerce and Industry (FICCI) and Confederation of Indian Industries (CII). As regards government departments and regulatory authorities, Reserve Bank of India, Ministry of Company Affairs, Central Board of Direct Taxes, Comptroller & Auditor
General of India, Controller General of Accounts, Securities and Exchange Board of India and Central Board of Excise and Customs are represented on the ASB. Besides these interest-groups, representatives of academic and professional institutions such as Universities, Indian Institutes of Management, Institute of Cost and Works Accountants of India and Institute of Company Secretaries of India are also represented on the ASB. Apart from these interest-groups, members of the Central Council of ICAI are also on the ASB.
The Accounting Standards-setting Process
The accounting standard setting, by its very nature, involves reaching an
optimal balance of the requirements of financial information for various interest groups having a stake in financial reporting. With a view to reach consensus, to the extent possible, as to the requirements of the relevant interest-groups and thereby bringing about general acceptance of the Accounting Standards among such groups, considerable research, consultations and discussions with the representatives of the relevant interest-groups at different stages of standard formulation becomes necessary. The standard-setting procedure of the ASB, as briefly outlined below, is designed in such a way so as to ensure such consultation and discussions:
Identification of the broad areas by the ASB for formulating the Accounting Standards.
Constitution of the study groups by the ASB for preparing the preliminary drafts of the proposed Accounting Standards.
Consideration of the preliminary draft prepared by the study group by the ASB and revision, if any, of the draft on the basis of deliberations at the ASB.
Circulation of the draft, so revised, among the Council members of the ICAI and 12 specified outside bodies such as Standing Conference of Public Enterprises (SCOPE), Indian Banks’ Association, Confederation of Indian Industry (CII),Securities and Exchange Board of India (SEBI), Comptroller and Auditor General of India (C& AG), and Ministry of Company Affairs, for comments.
Meeting with the representatives of specified outside bodies to ascertain their views on the draft of the proposed Accounting Standard.
Finalization of the Exposure Draft of the proposed Accounting Standard on the basis of comments received and discussion with the representatives of specified outside bodies.
Issuance of the Exposure Draft inviting public comments.
Consideration of the comments received on the Exposure Draft and finalization of the draft Accounting Standard by the ASB for submission to the Council of the ICAI for its consideration and approval for issuance.
Consideration of the draft Accounting Standard by the Council of the Institute, and if found necessary, modification of the draft in consultation with the ASB.
The Accounting Standard, so finalized, is issued under the authority of the Council.
Present status of Accounting Standards in India in harmonization with the
International Accounting Standards
So far, 29 Indian Accounting Standards on the following subjects have been
issued by the Institute:
AS 1 Disclosure of Accounting Policies
AS 2 Valuation of Inventories
AS 3 Cash Flow Statements
AS 4 Contingencies and Events Occurring after the Balance Sheet Date
AS 5 Net Profit or Loss for the Period, Prior Period Items and Changes in
Accounting Policies
AS 6 Depreciation Accounting
AS 7 Construction Contracts (revised 2002)
AS 8 Accounting for Research and Development (withdrawn pursuant to
the issuance of AS 26)
AS 9 Revenue Recognition
AS 10 Accounting for Fixed Assets
AS 11 The Effects of Changes in Foreign Exchange Rates (revised 2003)
AS 12 Accounting for Government Grants
AS 13 Accounting for Investments
AS 14 Accounting for Amalgamations
AS 15 Accounting for Retirement Benefits in the Financial Statements of
Employers (recently revised and titled as Employee Benefits)
AS 16 Borrowing Costs
AS 17 Segment Reporting
AS 18 Related Party Disclosures
AS 19 Leases
AS 20 Earnings Per Share
AS 21 Consolidated Financial Statements
AS 22 Accounting for Taxes on Income
AS 23 Accounting for Investments in Associates in Consolidated Financial
Statements
AS 24 Discontinuing Operations
AS 25 Interim Financial Reporting
AS 26 Intangible Assets
AS 27 Financial Reporting of Interests in Joint Ventures
AS 28 Impairment of Assets
AS 29 Provisions, Contingent Liabilities and Contingent Assets
Compliance with Accounting Standards
Accounting Standards issued by the ICAI had got legal recognition through
insertion of sections 211(3A), (3B) and (3C) in the Companies Act, 1956, which may be prescribed by the Central Government in consultation with the National Advisory Committee on Accounting Standards. Recent development in this regard is Accounting Standards 1to 7 and 9 to 29 as recommended by the ICAI, have been prescribed by Ministry of Company Affairs, Government of India vide its notification dated December, 7, 2006, in the Gazette of India. This notification provides that every company and its auditor(s) shall comply with the notified Accounting Standards.
The Securities and Exchange Board of India (SEBI) through the listing agreement requires that listed companies shall mandatorily comply with all the Accounting Standards issued by ICAI from time to time.
Also, the Insurance Regulatory and Development Authority (IRDA) requires
insurance companies to follow the Accounting Standards issued by the ICAI.
Apart from the corporate bodies, the Council of the Institute of Chartered Accountants of India has made various accounting standards mandatory in respect of certain non-corporate entities such as partnership firms, sole-proprietary concerns/individuals, societies registered under the Societies Registration Act, trusts, associations of persons, and Hindu Undivided Families, where financial statements of such entities are statutorily required to be audited, for example, under Section 44AB of the Income-tax, 1961. The Council has cast a duty on its members to examine compliance with the Accounting Standards in the financial statements covered by their audit in the event of any deviations there from, to make adequate disclosures in their audit reports so that the users of the financial statements may be aware of such deviations. I. INTRODUCTION AND PURPOSE OF THIS RELEASE
Over the last two decades, the global financial landscape has undergone a significant transformation. These developments have been attributable, in part, to dramatic changes in the business and political climates, increasing global competition, the development of more market-based economies, and rapid technological improvements. At the same time, the world's financial centers have grown increasingly interconnected.
Corporations and borrowers look beyond their home country's borders for capital. An increasing number of foreign companies routinely raise capital globally. This globalization of the securities markets has challenged securities regulators around the world to adapt to meet the needs of market participants while maintaining the current high levels of investor protection and market integrity.
The efforts to develop a global financial reporting framework have been guided by the cornerstone principle underlying the system of regulation -- pursuing the mandate of investor protection by promoting informed investment decisions through full and fair disclosure. Financial markets and investors, regardless of geographic location, depend on high quality information in order to function effectively. Markets allocate capital best and maintain the confidence of the providers of capital when the participants can make judgments about the merits of investments and comparable investments and have confidence in the reliability of the information provided.
Because of increasing cross-border capital flows, the securities regulators around the world have an interest in ensuring that high quality, comprehensive information is available to investors in all markets. All securities regulators should work together diligently to create sound international regulatory frameworks that will enhance the vitality of capital markets. Currently, issuers wishing to access capital markets in different jurisdictions must comply with the requirements of each jurisdiction, which differ in many respects. Different listing and reporting requirements may increase the costs of accessing multiple capital markets and create inefficiencies in cross-border capital flows. Therefore, securities regulators around the world should work to reduce these differences. However, ensuring that high quality financial information is provided to capital markets does not depend solely on the body of accounting standards used. An effective financial reporting structure begins with a reporting company's management, which is responsible for implementing and properly applying generally accepted accounting standards. Auditors then have the responsibility to test and opine on whether the financial statements are fairly presented in accordance with those accounting standards. If these responsibilities are not met, accounting standards, regardless of their quality, may not be properly applied, resulting in a lack of transparent, comparable, consistent financial information.
Accordingly, while the accounting standards used must be high quality, they also must be supported by an infrastructure that ensures that the standards are rigorously interpreted and applied, and that issues and problematic practices are identified and resolved in a timely fashion. Elements of this infrastructure include:
• effective, independent and high quality accounting and auditing standard setters;
• high quality auditing standards;
• audit firms with effective quality controls worldwide;
• profession-wide quality assurance; and
• active regulatory oversight.
I believe these issues should be considered in the development of any proposals to modify current requirements for enterprises that report using IASC standards because our decisions should be based on the way the standards actually are interpreted and applied in practice The elements of the infrastructure may be at different stages of development and that decisions and progress on some of these infrastructure issues may be independent of the body of accounting standards used.
II. ELEMENTS OF A HIGH QUALITY GLOBAL FINANCIAL REPORTING STRUCTURE
A. High Quality Accounting Standards
High quality accounting standards are critical to the development of a high quality global financial reporting structure. Different accounting traditions have developed around the world in response to varying needs of users for whom the financial information is prepared. In some countries, for example, accounting standards have been shaped primarily by the needs of private creditors, while in other countries the needs of tax authorities or central planners have been the predominant influence. In the United States, accounting standards have been developed to meet the needs of participants in the capital markets.
High quality accounting standards consist of a comprehensive set of neutral principles that require consistent, comparable, relevant and reliable information that is useful for investors, lenders and creditors, and others who make capital allocation decisions. High quality accounting standards are essential to the efficient functioning of a market economy because decisions about the allocation of capital rely heavily on credible and understandable financial information.
When issuers prepare financial statements using more than one set of accounting standards, they may find it difficult to explain to investors the accuracy of both sets of financial statements if significantly different operating results, financial positions or cash flow classifications are reported under different standards for the same period. Questions about the credibility of an entity's financial reporting are likely where the differences highlight how one approach masks poor financial performance, lack of profitability, or deteriorating asset quality.
The efficiency of cross-border listings would be increased for issuers if preparation of multiple sets of financial information was not required. However, the efficiency of capital allocation by investors would be reduced without consistent, comparable, relevant and reliable information regarding the financial condition and operating performance of potential investments. Therefore, consistent with the investor protection mandate, we are trying to increase the efficiency of cross-border capital flows by seeking to have high quality, reliable information provided to capital market participants.
B. High Quality Auditing Standards
The audit is an important element of the financial reporting structure because it subjects information in the financial statements to independent and objective scrutiny, increasing the reliability of those financial statements. Trustworthy and effective audits are essential to the efficient allocation of resources in a capital market environment, where investors are dependent on reliable information.
Quality audits begin with high quality auditing standards. Recent events have highlighted the importance of high quality auditing standards and, at the same time, have raised questions about the effectiveness of today's audits and the audit process. Are the training, expertise and resources employed in today's audits adequate?
Audit requirements may not be sufficiently developed in some countries to provide the level of enhanced reliability that investors in advanced capital markets expect. Nonetheless, audit firms should have a responsibility to adhere to the highest quality auditing practices -- on a world-wide basis -- to ensure that they are performing effective audits of global companies participating in the international capital markets. To that end, all member or affiliated firms performing audit work on a global audit client should follow the same body of high quality auditing practices even if adherence to these higher practices is not required by local laws.
C. Audit Firms with Effective Quality Controls
Accounting and auditing standards, while necessary, cannot by themselves ensure high quality financial reporting. Audit firms with effective quality controls are a critical piece of the financial reporting infrastructure. Independent auditors must earn and maintain the confidence of the investing public by strict adherence to high quality standards of professional conduct that assure the public that auditors are truly independent and perform their responsibilities with integrity and objectivity. It is not enough that financial statements be accurate; the public must also perceive them as being accurate. Public faith in the reliability of a corporation's financial statements depends upon the public perception of the outside auditor as an independent professional. In addition, audit firms must ensure that their personnel comply with all relevant professional standards.
The quality control policies and procedures applicable to a firm's accounting and auditing practice should include elements such as:
• independence, integrity and objectivity;
• personnel management, including proper training and supervision;
• acceptance and continuance of clients and engagements;
• engagement performance; and
• monitoring.
A firm's system of quality control should provide the firm and investors with reasonable assurance that the firm's partners and staff are complying with the applicable professional standards and the firm's standards of quality.
Historically, audit firms have developed internal quality control systems based on their domestic operations. However, as clients of audit firms have shifted their focus to global operations, audit firms have followed suit and now operate on a world-wide basis. Therefore, quality controls within audit firms that rely on separate national systems may not be effective in a global operating environment. Its a concern that audit firms may not have developed and maintained adequate internal quality control systems at a global level.
D. Profession-Wide Quality Assurance
The accounting profession should have a system to ensure quality in the performance of auditing engagements by its members. Necessary elements of the system include:
• providing continuing education and training on recent developments;
• providing an effective monitoring system to ensure that:
o firms comply with applicable professional standards;
o firms have reasonable systems of quality control;
o there is an in-depth, substantive and timely study of firms' quality controls, including reviews of selected engagements;
o deficiencies and/or opportunities for improvements in quality controls are identified; and
o results of monitoring are communicated adequately to the appropriate parties.
• providing an effective and timely disciplinary process when individuals or firms have not complied with applicable firm or professional standards.
In some jurisdictions the local accounting profession may have a system of quality assurance. However, structures focused on national organizations and geographic borders do not seem to be effective in an environment where firms are using a number of affiliates to audit enterprises in an increasingly integrated global environment.
E. Active Regulatory Oversight
The sound financial reporting structure has a number of separate but interdependent elements, including active regulatory oversight of many of these elements, such as registrants' financial reporting, private sector standard-setting processes and self-regulatory activities undertaken by the accounting profession. Each of these elements is essential to the success of a high quality financial reporting framework. This oversight reinforces the development of high quality accounting and auditing standards and focuses them on the needs of investors. It provides unbiased third party scrutiny of self-regulatory activities. Regulatory oversight also reinforces the application of accounting standards by registrants and their auditors in a rigorous and consistent manner and assists in ensuring a high quality audit function.
While we must have a framework that minimizes the risk of fraud and malpractice if we are to sustain and nurture investor confidence, no investor should delude themselves. Tougher regulations and laws may help stamp out false accounting. But creative accounting will always be with us - even if recent developments in international accounting standard setting makes it more challenging. That’s why the task of the non-executive director, of the fund manager, of the banker, of the supplier or of any other interested party in a company’s underlying financial health is to ask the many questions that the published accounts don’t answer.
Published accounts will always be like bikinis - much more interesting for what they conceal than for what they reveal -regardless of more exacting accounting standards,
The view that more frequent reporting by companies increases transparency is one about which I am deeply sceptical.
It is too easy to massage a set of quarterly or half yearly figures.
Take a branded goods business. Put it on a brand investment diet for a short time – say one accounting period. That will save costs and boost margins – for that accounting period. But in the next accounting period margins, brand equity, and sales will suffer.
Take a service business. You can skimp on investment in staff training and investment and thereby boost profits in one period. But probably at the expense of customer service quality, loyalty, and profitability in the following period.
Take a manufacturing business. You can stuff distribution channels to the benefit of sales and margins in one accounting period. But it will surely be at the expense of those same sales and margins in the following period.
Take any balance sheet. By manipulating working capital, a company balance sheet that looks cash rich at the end of one quarter could, as you well know, be facing a liquidity crisis in the following quarter.
That is to say nothing of the manipulation opportunities from capitalization of expenses as assets in the balance sheet that might more appropriately have been expensed as costs in the profit and loss account.
Some changes in accounting rules may have reduced the scope for some of these practices. But none has stopped them- nor are they likely to.
I would like to conclude with a piece of advise , never let satisfaction about a business’s compliance with the fine print of accounting standards overcloud your better judgments about the underlying commercial realities.
