ndian business has gone global in a big way in recent years, which is clearly reflected in more companies setting up overseas arms, raising money from the market and acquiring companies. The coming years will only see an increase in the number of companies getting more globalised in their operations. In such a scenario, there is a pressing need for adoption of global Accounting Standards (AS), says Mr R. Narayanaswamy, Professor of Finance and Control at IIM- Bangalore.
Speaking to Business Line on the wide-ranging implications of adopting global AS and how it can benefit corporates and the country as a whole, he urges the shift towards these standards as they have "wide international recognition because of their quality, coverage and acceptability. Indian companies can communicate cost-effectively with the rest of the world if their financial statements comply with global standards."
According to him, investors — especially from overseas — customers, suppliers and employees will then have more faith in the numbers that the companies churn out. Other benefits include lower cost of raising equity and debt capital, greater liquidity for shares and lower bid-ask spreads. "All of these result from reduced information asymmetry between managers and outsiders."
Global Standards
Currently, the standards and other pronouncements issued by the IASB and FASB are the two systems that are competing for this status.
Would such a move entail dismantling of national AS structures such as the ASB of the ICAI? Mr Narayanaswamy, a PhD in Accounting from the University of New South Wales, Sydney, clarifies that a country that adopts international standards examines them for conformity with national laws and practices. "We would still need a national accounting standard-setter with superior technical and financial resources."
He cites the example of the Australian Accounting Standards Board, which continues to exist and play an important role, though Australia has adopted IAS/IFRS. There are no international standards that do not apply to India, he adds. On the Indian system of AS generation, which involves authorities and organisations such as the RBI, the SEBI, the ICAI and the CBDT, the biggest problem is multiplicity, "which happened mainly because the accountants were slow and lukewarm in their response. For a long time, I have been making a case for an independent accounting standards body with full-time members."
After all, accounting is too serious a matter to entrust to accountants, he quips.
No Monitoring
On a more serious note, Mr Narayanaswamy, a member of the ICAI, the ICWAI and the ICSI, expresses concern that there is little effective monitoring of reporting entities following the mandatory AS.
"I doubt if anyone is monitoring compliance. Both the SEBI and the MCA do not have the kind of technical staff they need. This is a task that the ICAI cannot do satisfactorily, because there are obvious conflicts."
According to him, the Securities Exchange Commission (of the US) provides an excellent model for high-quality monitoring of all corporate filings. In the UK, the Financial Reporting Review Panel raises important questions and in many instances gets the statements amended. These are worthy of emulation, he adds.
On the gaps in Indian GAAP, and how they can be plugged, he says: "We do not have a set of Indian standards dealing with financial instruments, but the exposure drafts have been out for a while. There is no standard on business combinations; the one that we have — AS 14 — deals only with amalgamation, but businesses largely come together by means of inter-company investments."
According to him, some of our standards are "very much out of date and need to be reworked," especially those relating to revenue recognition, leases and presentation of financial statements. To most readers of annual reports, AS references may be abstruse. So, how does a company go about effectively communicating to the business reader the effect accounting standards have on reported financial performance?
"The lay reader needs assurance that managers prepare financial statements faithfully in accordance with high-quality AS and the company's auditors are satisfied with the statements."
But, increasingly, standards seem to getting more complex and addressing the needs of professional analysts and investors more than shareholders. "This is because business transactions are getting more complex."
He adds: "For example, to be able to understand the standards on financial instruments, stock options, pensions or segments, the reader should have a good knowledge of business and financial operations. However, management should make its point in plain English."
Mr Narayanaswamy is all for accountants understanding how business organisations work. "Accounting follows business. So, it would be useful for accountants to understand how new products are developed, how projects are managed, what drives M&As, how tax planning relates to business planning, or how risk is managed using financial instruments such as derivatives."
According to him, providing comparisons with other jurisdictions, and then explaining reasons for any differences in AS, is another way of igniting interest in standards. Another "appealing method" is using published annual reports and media reports to illustrate the difference between good and bad accounting.
Can changes in the law give AS a boost? "A simple way would be to empower shareholders by allowing private shareholder litigation against company management and auditors. As the company and securities laws stand now, only the company can sue its managers and auditors for damages for their failure to show due care and diligence in their work, " says Mr Narayanaswamy whose current research interests include corporate disclosure policy, earnings management and strategic cost management.
Since shareholders cannot sue even though they are the real losers in company failures, he wants them to be allowed to take care of their interests. "That would be a major step forward, though I am not for class action suits at the moment."
Equally important is strengthening the corporate governance system, especially independent directors and audit committees, improving audit quality and independence, and reforming the legal regime.
Are software hardwired?
Do accounting software products factor in AS, thus reducing the compliance worry for accountants? "Gradually, many products are becoming XBRL-compliant. Adoption of XBRL will greatly reduce the cost of preparing financial statements for multiple purposes, such as shareholder reporting, tax reporting and reporting to regulatory agencies. Nevertheless, costly modifications to information systems are often unavoidable."
Going beyond technicalities and looking at the bigger picture, he says that managers should understand that "bad accounting is eventually bad for all of us. Accountants should focus on the larger purpose of financial reporting. Principle-based accounting standards presumes that we can the trust accounting and business professionals to make fair and reasonable judgements. If someone breaches that trust, everyone will have end up having to pay a huge cost by having to comply with horrible rule-based accounting standards. I hope we don't have to get there."
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