What happens when the laws of gravity are temporarily suspended? Sooner or later, gravity catches up. In their attempt to suspend the laws of accounting, Indian companies are about to learn that lesson.
Succumbing to pressure from corporate lobbies, the government last week went ahead with temporarily suspending a key accounting norm. Accounting Standard (AS) 11 mandates that a company must mark foreign exchange gains or losses to market prices, and reflect this in its quarterly profit and loss (P&L) account.
Illustration: Jayachandran / Mint
Corporations argue against AS-11 because the rupee has seen wild fluctuations. True, a $1,000 loan from a US bank, worth Rs39,000 in 2008, is now worth Rs50,000. That’s a Rs11,000 increase in liability that, according to AS-11, must be deducted from a company’s P&L. Suspending AS-11 would mean ignoring the Rs11,000 loss.
This loss is instead transferred to the “Foreign Currency Monetary Item Translation Difference Account” on the balance sheet, something so esoteric that it’s sure to mislead investors trying to figure out the company’s worth. But transparency isn’t the only victim. A recent report from Ernst and Young shows that firms could end up increasing their tax liability. The AS-11 suspension decreases losses on the P&L but increases assets on the balance sheet, which translates into that much more tax the company owes. The suspension is also retroactive from December 2006, which means tax owed from previous periods. Accountants will wake up to find a new tax burden, come next fiscal year.
Firms will have to keep this in mind. But in a rush to avoid showing losses, this advice may fall flat on their ears. Consider the latest corporate debacle: Mint reported on Tuesday that Habil Khorakiwala, chairman of Wockhardt Ltd, attributed the drug maker’s financial problems to forex mark-to-market and derivatives losses. This narrative would have us believe that sidestepping AS-11 easily avoids these losses.
Yet, this narrative shifts blame away from firms such as Wockhardt, which may have invested in complex cross-currency hedges that now leave them too exposed.
These firms don’t want to own up to their foolhardiness or accept the immutable truth of business cycles: What rises in a boom can fall in a bust. So, they alter gravity’s laws, forgetting that the apple will one day land on their heads with a thud.
Will AS-11 come back to haunt companies? Tell us at email@example.com