The Confederation of Indian Industry (CII) recently asked the Institute of Chartered Accountants of India (Icai) to review the accounting standards that require foreign currency assets and liabilities be marked to market. Last week, Mint reported that the National Advisory Committee on Accounting Standards (Nacas) proposed that accounting standard (AS)-11 that covers forex gains and losses can effectively be ignored till 2011.
Nacas’ decision makes a mockery of accounting standards. Ironically, in February 2006, the very same Nacas had reviewed Icai’s accounting standards and recommended that AS-11 be adopted. So, Nacas believes AS-11 is good from 2006-2009; but bad from 2009-2011; and then again quite alright from 2011. It is extremely disappointing that Nacas has bowed to the pressure from industry lobbies. Indian companies, looking to avoid declaring their losses, aren’t helping their post-Satyam image of accountability and transparency.
CII’s contention is that foreign currency-denominated long-term items need not be marked to market every quarter. CII argues for allowing companies to book gain or loss in a given quarter in proportion to the time left for the underlying item to mature.
Say, a company takes a five-year term loan of $1 million from a US bank on 1 October 2008, when the rupee-dollar exchange rate was at 45. The liability is reflected in the books of this company as Rs4.5 crore. If on 1 January 2009 the exchange rate is at 49, then the liability is Rs4.9 crore. This difference of Rs40 lakh is debited to the company’s profit and loss account, reducing its profits. CII argues that this Rs40 lakh loss is “notional” since nothing has changed to alter the loan.
This argument is specious: The value of the liability in rupees has actually increased by 8.8%; as has the interest burden on the loan. Surely, the books of accounts should reflect the current financial state of a corporation. Should corporations, effectively, ignore market circumstances?
Then there’s the issue of how investors should value a company. If a company resorts to taking its forex losses off its balance sheet, is an investor expected to decipher these esoteric nuances from the notes to accounts? This is how frauds such as Enron begin.
It is very convenient for CII to wake up to this accounting issue when the rupee is depreciating against the dollar. Why was no voice raised on this issue 12 months ago when corporations showed forex gains, thanks to the downward revaluation of their external commercial borrowings? There ought to be consistency on this matter. From October to December 2007, forex gains due to loans formed 16.3% of Ranbaxy’s total profit after tax; while forex loss due to loans was 21.3% of its total loss after tax the same period in 2008.
Deciding that mark-to-market is fine when one can show a profit and bad when there’s a loss is rank opportunism. Nacas’s move will abet misrepresentation of books.
Next, banks will say that they need not mark the value of long-term mortgages to the market “due to the extraordinary market conditions”. They will argue that housing loans are for 15-20 years and hence, fluctuations in the underlying asset need not be marked to market, even if the value of the underlying collateral is half the value of the loan.
What CII is suggesting is “dressing up the books” and not book keeping. Good accounting standards should bring out the inherent volatility in a system and not “paper over” problems. After Satyam, when the accounting fraternity is under the public’s microscope, Nacas’ time would be better spent in helping make financial statements more transparent and not more opaque.
Puranika Narayana Bhatta is chief financial officer at a software company in Bangalore. Comment at email@example.com