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A leap in the direction of financial reforms... - Views on News from Equitymaster
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  • Jan 11, 2011

    A leap in the direction of financial reforms...

    The wait is over. India is ready to take the next leap in the direction of financial reforms. We are talking about the decision to switch from current accounting standards to IFRS. Now that the impact of global economic crisis has subsided and Indian stock markets are flush with FII funds, the timing could not have been better. The move will also facilitate access to foreign capital and business expansion abroad. With this adoption, the substance will take precedence over form.

    One of the key traits of IFRS is using fair values rather than historical values. We expect the practice to promote effective decisions at the corporate level. The fair disclosure and transparency will let investors take well informed decisions. Also, India being one of the one of the early members to follow it, will have a say in the way IFRS evolves in the future.

    However, the switch is not without itches. It is argued that fair value reporting can be manipulated by management where current market for the asset does not exist. We believe that the argument does not hold water for two reasons. The first is that the historical values may not be a correct determinant of current asset value. Second, the problem can be dealt with using strict auditing practices like valuation of assets by more than one party.

    Another road block in way is discomfort of power companies to adopt IFRS. As of now, the power companies account most of their revenues from power purchase contracts (PPA). The PPA is a contract between power provider and power purchaser. As per Indian accounting standards, the provider gets funding, takes care of power production and sells it to purchaser as per the terms mentioned in the contract. Hence, these are shown as purchases and sales i.e. sale of electricity and revenue from sales are shown in the income statement of the relevant period. Under IFRS, such PPAs will have to be checked if they qualify for finance lease agreement. This may cause the P&L and Balance Sheet items to change drastically and may hit the leverage and profitability ratios. It can even stifle viable funding for the projects. Having said that, the solution is not a delay in using IFRS but a change in the Electricity Act and banking regulations.

    A lot of issues need to be taken care of by the regulators, government, companies and other stake holders. The switch may not be all smooth initially but it does deserve a try. The step will increase the global confidence in Indian economy and will keep experiences like Satyam at bay. The real concern is the time and the ability of Indian accountants and auditors to make this move. There is also a need to educate all the concerned parties. Also, since we are going for convergence and not a blind adoption, we hope the standards and applications are not distorted in a way that we get lost in transition. If implemented well, the move will only lead to better corporate governance and lesser scope for manipulation.



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