Akhil Bansal 27 July 2007

1. Compliance with Accounting Standards Akhil Bansal 27 July 2007

2. Measurement Science Test each accounting principle for its capacity for measuring and disclosing • Wealth: Net worth, net assets, assets and liabilities • Performance: Inputs, outputs, expenses, income • Liquidity: Cash inflows, outflows from operations, financing and investment

3. Reporting framework evolves over time • Stages of economic growth • Globalisation efforts • Corporate ethics • Institutionalisation of capital markets • Stakeholders’ expectations

4. The US experience Macro developments trigger reporting advances

5. Similar experiences across continents • United Kingdom • Accounting standards introduced in 1972 • Kept pace with developments in the US • Australia • Independent standards formed in 1983, earlier worked on IASC recommendations • 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

6. 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

7. ICAI - Big leap in financial reporting * Revisions Revisions Accounting standards 2 Auditing and Assurance Standards 3 Indian GAAP is being modified on a continuous basis

8. 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 materiality • Test each auditing issue for its capacity for adding credibility to given propositions/assertions

9. 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 Mandatory documents on accounting Purpose • 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 • In the event of any deviation from a mandatory standard the auditor is required to make adequate disclosure in his report Reporting

10. Auditor’s duty in relation to a mandatory accounting standard in case of companies Ascertain accounting policy followed and disclosure made by the enterprise Is accounting policy as per standard? Is disclosure as per standard? No No Make negative statement under section 227(3)(d) Make negative statement under section 227(3)(d) Yes Make positive statement under section 227(3)(d) Yes Is there a violation of legal requirements? Yes No Is effect of deviation material? Yes Is true and fair view affected? Yes Qualify the audit report No No further action required No

11. Materiality • 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

12. Materiality • Whether a misstatement masks a change in earnings or other trends or hides a failure to meet analysts’ consensus expectations • 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 business

13. 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) COMPLIANCE WITH ACCOUNTING STANDARDS IS A LEGAL REQUIREMENT !!

14. 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 forCOMPANIESfor accounting periods commencing on or after 7 December 2006 For annual accounts for period ending 31 December 2006 or 31 March 2007 ICAI standards would remain applicable even in case of companies The Notified standards by and large follow the ICAI standards except for certain differences

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

16. Relaxations/Exemptions available to SMCs AS 3, Cash flow statements AS 17, Segment reporting Full exemption ARE THE RELAXATIONS/EXEMPTIONS JUSTIFIED? AS 28, Impairment of assets AS 20, Earnings per share Limited exemptions AS 29, Provisions, contingent liabilities and contingent assets AS 19, Leases

17. 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) standard ? 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 standards

18. 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

19. The four “AXIOMS” • Incomplete information creates UNCERTAINTY • Uncertainty creates RISK for Investors & Creditors • Risk makes investors & creditors demand a higher Rate of Return (ROR) • Higher ROR means higher cost of capital for the company and produces LOWER market values of company’s securities

20. Quality financial reporting • More complete information that will reduce uncertainty • Less uncertainty will reduce risk for investors and creditors • 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

21. Peer review norms for auditors of listed companies 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 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

22. Who audits the auditor? Effective for auditing firms from 1 April 2003 One of international best practices 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

23. 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 FUNCTIONS • 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 requirements

24. Financial Reporting Review Board (FRRB) FRRB • ICAI constituted FRRB in 2002 • Panel to be a sub-group within the Central Council but may form a part of QRB once the new law is implemented Objective • 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 only • Reviews by FRRB would not be verification of the entire audit (re-audit) or review of working papers of the auditors

25. 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 Scope • Enterprises whose debt or equity securities are listed on a 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 Enterprises covered

26. Financial Reporting Review Board (FRRB) • Either suo motu or on a reference made to it by any regulatory body • Enterprises relating to which serious accounting irregularities in the general-purpose financial statements have been highlighted by the media reports Selection of enterprises Implications of findings • Auditor: Findings of the panel to form an input for disciplinary action committee to punish members found to be grossly negligent • Company: Pending grant of relevant powers by Government, communicate the irregularity to the relevant regulatory body and company’s management Implications of findings

27. 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

28. Serious Fraud Investigation Office (SFIO) Cases investigated by SFIO are characterised by Complexity and having inter-departmental and multi-disciplinary ramifications Substantial involvement of public interest to be judged by size, either in terms of monetary misappropriation or in terms of persons affected Possibility of investigation leading to or contributing towards a clear improvement in systems, laws and procedures

29. Six key issues “that underlie the financial reporting reform debate” • MULTIPLE STAKEHOLDERS - can business reporting satisfy needs of all stakeholders • 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 reporting • 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

30. Focus areas for the future • Strengthen quality of reports : MD&A, Corporate Governance • Derivatives • Follow the thought leaders • Value reporting • Sustainability reporting • Corporate Governance ratings • Adoption of IFRS –yet another challenge !

31. 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)

32. 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 uniform

33. Is it possible to have convergence? • Accounting measurements take place in a dynamic world with different environments • Political thought • Nature, size and complexity of business enterprises • Nature & size of capital markets • Stability of currency • Legislative environment • Social environment • Degree of centralisation in the economy • Stage of economic development/inflation • 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

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

35. 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

36. Thank you

37. 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!

38. Compliance with accounting standards - move towards transparency and challenges

39. 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

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

41. 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 markets • Definitive actions are needed by a range of parties to address legitimate concerns, better protect the public interest, and restore investor confidence

42. A new reporting relationship Management, auditors and audit committees each has a separate role and responsibilities BUT The goal must be the same MAKING SURE THAT A COMPANY’S FINANCIAL REPORTING IS OF THE HIGHEST QUALITY GOAL

43. 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

44. Lessons from the past Learning from experience Document conclusions especially on subjective matters Review whether changes in accounting policies and accounting estimates are not for earnings management Be thorough Be challenging and skeptical Ensure adequate and appropriate disclosures Follow up errors and exceptions Consider the impact of non – compliance, if any, with laws and regulations Review effectively Accounting policies should be worded as closely as possible to the text of the standard