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Massive changes are likely to take place as per the new Accounting Standards (AS). The new AS will certainly change the way in which the revenues and assets and liabilities are calculated. Further, it will also mandate more disclosures from companies. As the fundamentals change due to the new AS, will the same lead to a rerating on the stocks?
Let us highlight few of the significant changes that are likely to take place. First being revenue recognition. Till date, if a company sells a consumer durable product worth Rs 1 lakh, it immediately recognizes sales of the whole amount i.e Rs 1 lakh. However as per the new AS, the company needs to recognize the revenue taking into consideration the future cost of the spare parts if the warranty is exercised. Therefore if the cost of the spare part is Rs 5000, the company can recognize sales immediately only to the extent of Rs 95,000. The company can recognize the balance Rs 5000 over the period of warranty. This can significantly impact the revenues of the company for a particular fiscal year.
Second being classification of financial instruments. The new AS states that any financial instruments having an obligation to deliver cash will be classified as debt. This accounts for major re-classification. Till date, preference shares were classified under equity component. However as per the new AS, preference shares will be classified as debt because they carry fixed obligation to pay divided on them. This will significantly impact the debt-to-equity ratio of the companies.
Third being, reporting of assets and liabilities at their fair market value (FMV). Till date, assets and liabilities were recorded at their historical values i.e original cost. However, new AS states that the assets and liabilities will be recorded at their FMV. Recording of assets at their FMV will lead to higher depreciation and consequently lower profits. However recording of assets and liabilities at their FMV will give a more realistic picture to the investors in relation to the state of affairs of the company.
The proposed changes will definitely have an impact on the financials of the company and may lead to rerating on the stocks. However, decisions on investment cannot be based on the changes in the way financial statements are presented or prepared. More emphasizes should be laid on the fundamental strength of the company. Hence long term prospects of the company and economic moats should also be given prime importance before taking any investing decisions.
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