Module: 4
Financial Standards and Codes: Report of Advisory Group on International Accounting and Auditing

The Way Forward - Recommendations of the Committee

Bridging the Gap

As has been illustrated earlier there exists a significant gap between the standards issued by IASC and the standards issued by ICAI. As a result of initiatives taken by the Accounting Standards Committee of SEBI and ICAI, four key standards have been issued or are expected to be issued shortly. However, the gap remains pronounced in respect of standards related to financial institutions and it is necessary that ICAI take up on an emergency basis the issuance of standards comparable to (a) IAS 30 "Disclosures in Financial Statements of Banks and Similar Financial Institutions" (b) IAS 32 "Financial Instruments : Disclosure and Presentation" and (c) IAS 39 "Financial Instruments : Recognition and Measurement".

With the endorsement which IASC has received from IOSCO and the European Commission and with the reconstitution of the IASC, the gap between International Accounting Standards (IAS) issued by IASC and US GAAP will considerably narrow and IAS will be increasingly accepted by stock exchanges and international lenders and investors all over the world. The accounting standards issued by ICAI are already anchored on the corresponding IAS.

It should be the endeavour of the ASB that Indian Accounting Standards should correspond as far as possible to International Accounting Standards. It should therefore be mandatory that if there is a departure in the Indian standard from the corresponding International Standard, there should be a note to the Indian standard which identifies such departure and explains the reason for the departure. This will help identify the causes of difference and can trigger action for remedial action, if required.

Currently, it takes on an average between eighteen months to two years for the issuance of an accounting standard. It will be difficult to clear the back-log and to keep track with the new standards issued by IASC while at the same time maintaining the required quality and the benefit of consultation with various interest groups unless the organisation of the Accounting Standards Board (ASB) is reviewed. The following matters need to be considered in this behalf:-

1. The ASB consists of as many as 21 members including 13 members of the Central Council of the Institute and 8 other co-opted members. None of the members are full time members. In addition, there are 6 permanent invitees from concerned bodies like SEBI, UGC, IIM etc. In contrast, in USA, the Financial Accounting Standards Board (FASB) has only 7 members who are full time and the reconstituted IASC will have only 14 members of whom 12 will be full time and 2 part time members who will be devoting almost 50% of their time to the work of IASC.

2. Both the FASB and IASC will be autonomous bodies, with their own independent funding. The ASB on the contrary is a Committee of ICAI. Therefore, it has no independent staff or funding and while it has as co-opted members some individuals who are not Council members and some permanent invitees representing other interests, like any other committee of the ICAI, it is subject to the overall control of the Council

3. In both the FASB and the reconstituted IASC, members will be selected primarily for their technical expertise. By the very nature of its constitution, the ASB membership would find it difficult to satisfy this test.

4. The reconstituted IASC provides for a two-tiered structure viz., a Board of Trustees and a Standard-Setting Board. The former presumably will oversee the functioning of the Standards-Setting Board and appoint its members but will not participate in the standard-setting process. The ASB on the contrary combines both functions.

5. It may therefore be appropriate to consider restructuring the ASB on the following lines:-

   1. The ASB should be an autonomous body within the ICAI with its own staff and with independent funding.

   2. There should be a two-tier structure like the IASC with a board which is a small committee consisting of Council members and co-opted members. In addition there should be a Standard-Setting Committee consisting of members who should be selected primarily for their technical expertise. The Chairman of the Committee should be a full-time member.

   3. While the ASB would supervise the functioning of the Board and select the members of the Standard Setting Committee, the Committee would have full autonomy for the standard-setting process.

   4. There should be adequate representation of the regulators i.e. Department of Company Affairs, Central Board of Direct Taxes, Securities and Exchange Board of India and Reserve Bank of India on the ASB.

   5. The standard setting procedure outlined in Annexure II may be amended as outlined in Annexure IIA.

It is also necessary that there should be only a single standard setting authority within the country. With the reconstitution of the ASB on the lines suggested above, it should not be necessary to have a National Advisory Committee on Accounting Standards as provided in the Companies Act, or for the Central Government to notify Accounting Standards under the Income Tax Act. Equally, it should not be necessary for the RBI to issue directions on accounting matters to banks and financial institutions and NBFCs in respect of matters which are already covered by the standards. Where there are matters which are not covered by standards or where there are matters of interpretation of standards or detailed application thereof, the RBI may issue directives, but such directives must not be inconsistent with the standard issued by ICAI. It would also be helpful if the RBI were to monitor the standards issued by ICAI on accounting for financial institutions in the context of parallel standards issued by IASC on the same lines as is done by SEBI's Accounting Standards Committee.

. Many of the differences between the standards issued by ICAI and IAS arise because of differences in corporate and tax laws in India and in other countries. Many of these have been highlighted earlier. It is necessary that the provisions of the Companies Act be examined to determine whether the relevant provisions of the Act are necessary and whether these provisions can not be suitably amended.

For example,

1. Section 78 permits the Share Premium Account to be utilised to write off preliminary expenses, to write off the expenses of or the commission paid or discount allowed on any issue of shares or debentures of the company or to provide for premium payable on redemption of preference shares or debentures. International practice is to charge all such items to the Profit and Loss Account.

2. The form of Balance Sheet and the requirements as to Profit and Loss Account in Schedule VI require that provision should be made for proposed dividends but international practice is to the contrary.

3. The form of Balance Sheet given in Schedule VI requires that an increase or decrease in liability in respect of foreign currency loans used for purchase of fixed assets consequent on changes in exchange rates should be added to the costs of assets. There are provisions for calculation of cost under Section 43A of the Income tax Act which are similar to the provisions of the Income Tax Act. International practice is to treat such increases or decreases as items of expenditure or income.

4. Section 211 which deals with the form and contents of Balance Sheet and Profit and Loss Account and Section 212 which requires the Balance Sheet of a holding company to include certain particulars as to its subsidiaries, but does not require the preparation of Consolidated Balance Sheet and Profit and Loss Account although the international practice requires preparation of consolidated accounts.

Section 145 of the Income tax Act 1961 provides that "profits and gains of business or profession" or "income from other sources" has to be computed in accordance with either cash or mercantile system of accounting regularly employed by the assessee. However, there are other provisions of the Act e.g. Section 145A regarding treatment of Modvat, which provide for accounting treatment which is not in consonance with the accounting standards laid down by ICAI and IAS.

It is unrealistic to expect voluntary acceptance of accounting standards if such acceptance puts the user to an economic disadvantage. It is, therefore, necessary that tax laws provide for the minimum divergence between taxable income and accounting income particularly if such divergence arises from different accounting methods used for computation of taxable income and for preparation of financial statements. It should, therefore, be provided that for the purposes of section 145 of the Income-tax Act, 1961, the income should be computed in accordance with accounting standards issued by ICAI. Where the standard permits of alternative treatment e.g. depreciation under the diminishing balance method and under the straight line method, the Act or Rules thereunder can specify the alternative which would be used for the calculation of taxable income. Such a provision with a minimum of special provisions which over-ride section 145 of the said Act, would also go a long way in reducing litigation and provide for better tax compliance.

It needs to be recognised that there will always remain a gap, however small, between the standards issued by IASC and the standards issued by ASB. There will also be areas - particularly newly emerging areas - where IASC standards may not have been formulated. For these and other areas where accounting controversies develop, the need for interim guidance arises to ensure that uniform accounting policies are followed. In the U.S., these issues are addressed by the 'Emerging Issues Task Force' (EITF) established by FASB as a high powered committee with representation from different quarters. The EITF deliberates on an urgent basis on any emerging issue or accounting controversy and provides a consensus opinion to nip the controversy in the bud. Similarly, the IASC has a Standing Interpretation Committee which issues interpretations on some of the matters contained in the standard on which clarification is considered necessary. The Institute already has an Expert Advisory Committee. However, this Committee is concerned with answering specific queries referred by institutional members and its pronouncements represent only the individual views of its members and are not binding on the Institute. It is necessary that the ASB appoint a separate committee, consisting solely of persons selected on the basis of their technical expertise, to which committee matters of general concern are referred and whose pronouncements have the authority of interim pronouncements issued by the Institute.

Finally, it is necessary to have a mechanism in place to ensure compliance with the standards. In the U.S., the Securities Exchange Commission (SEC) carries out scrutiny of all public filings and enters into a lengthy dialogue with companies filing financial statements to ensure total compliance to its satisfaction. If the changes suggested by SEC are not carried out, the filing is not permitted. In the UK, there is a Financial Reporting Review Panel which is charged with the responsibility of policing company accounts. Since the Panel was introduced in the early 1990s there has been a 'fall-off' in the number of cases examined by the Panel and it is argued that the mere existence of the Panel has served as a deterrent to those who might adopt an accounting treatment which is not in accordance with accounting standards. There has been a contrary view that the 'fall-off' is evidence that as the Panel adopts only a reactive approach - examining only those cases where it receives complaints - serious cases of violation may be escaping its attention. It may be necessary to establish such a body-either within the ICAI or outside - to monitor compliance with accounting standards. The requirement in the Companies Act that departures from accounting standards must be disclosed in the financial statements and that auditors must report whether accounting standards have been followed provides a mechanism for the identification of violations. What needs to be further provided is for an obligation on auditors to report directly to the Panel all cases of violation. But this by itself may not be sufficient and the Panel may need to examine on a test-check basis a few of the financial statements where no violation is reported.