Trends and Ideas in Accounting and Auditing

Himanshu Kishnadwala

“As the force of globalization takes full effect, the international accountancy profession, more than ever, needs to exert its leadership in developing and promoting adherence to high quality and consistent professional standards; in encouraging all those involved in the financial reporting process to act with the utmost integrity; in assisting developing nations in establishing transparent and accountable financial systems; and in providing the resources and support to assist professional accountants in business and those in small and medium enterprises and practices in carrying out their responsibilities.”   -- Message from Graham Ward, President, IFAC for the World Congress of Accountants, held at Istanbul from 13-16 November 2006

DEVELOPMENTS IN THE INTERNATIONAL ACCOUNTING PROFESSION

With Enron in USA, Parmalat in Europe and other scams that have hit the headlines, the confidence of the world on the accountancy profession has been waning. It has taken stringent legislation (in the form of Sarbenes Oxley Act in US and the Corporate Governance Code in India) to restore some of this confidence.

Since 2002, the international accountancy profession is also undergoing a major upheaval. As a result of the Norwalk Agreement signed by the US Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB), FASB and IASB have agreed to converge the US accounting standards and those issued by IASB and develop high quality compatible accounting standards (to be called International Financial Reporting Standards – IFRS) that could be used for both domestic and cross-border financial reporting. The FASB and IASB seek to ensure adherence to high quality professional standards and are committed to the establishment of transparent accounting and financial systems. This alone will ensure that the confidence of the end users of the services of the accountancy profession is not lost, in an era where globalization is leading to smaller and flatter world. 

DEVELOPMENTS IN INDIA

The developments and trends taking place in the fields of accounting and auditing in India in the last 10 years also reflect the above international trends and developments. As the forces of globalization prompted India to open its doors to foreign investment and as the Indian companies expanded across borders, both the public and private sectors increasingly recognized the benefits of having a commonly understood financial reporting framework supported by strong globally accepted auditing standards.

Though India had been lagging behind in issuing accounting standards, the ICAI has, in recent times, promulgated a spate of new accounting standards. The fast pace at which the ICAI has worked in order to keep abreast with the rest of the world can be seen from the fact that only 15 Accounting Standards were issued from 1982 (when the Accounting Standards Boards was established) to 2000, whereas since 2001, 14 more Accounting Standards have already been effected and another 7 are in the pipeline.

Some of the recent Accounting Standards are quite complex and involve new concepts like deferred taxes, recognition principles for intangible assets, etc. There is a chance that these concepts may not be uniformly interpreted and followed. To reduce ambiguities, ICAI has also issued 29 Accounting Standard Interpretations (ASIs).

In addition to the formulation of the Accounting Standards, ICAI has also been active in issuing Auditing and Assurance Standards (AAS). AAS (or SAPs as they were earlier called) are mandatory for auditors to follow while giving their opinion on the “truth and fairness” of financial statements. The AAS issued by the Auditing and Assurance Standards Board of ICAI follow the International Standards on Auditing (ISAs) issued by IFAC. Till date, ICAI has issued 34 AAS.

TRENDS/PRACTICES ON ADOPTION OF ACCOUNTING STANDARDS

The adoption of new Accounting Standards (such as AS-22: Accounting for Taxes on Income, AS-28: Impairment of Assets, etc) has affected profitability of companies. This is in view of the stringent recognition and measurement guidelines laid down by the new Accounting Standards. The new Accounting Standards also require that adequate training be imparted to both accountants and CFOs. Auditors also have had to grapple with interpretation issues. In many cases, where clarifications have not been readily available, the benefit of the doubt has, more often than not, been given to the companies.

Some of the trends and practices followed by companies in the recent past in complying with these Accounting Standards are enumerated below:

a)             Following higher materiality levels: In practice, materiality levels are selected for not providing for outstanding expenses, not capitalizing fixed assets below a certain threshold, etc. (For e.g., writing off of all fixed assets below Rs. 25,000 rather than capitalizing the same)

b)            Early adoption of Accounting Standards: Many companies, especially forward looking companies have adopted the new AS earlier than when they became mandatory. No doubt, the impact of the same on the profitability would also have been a factor for such early adoption. (For e.g., adoption of AS 15 on Employee benefits for the year 2005-06 by Bajaj Auto Ltd)

c)             Providing for Impairment of Assets as per AS 28 also posed a major challenge to companies. Companies took a long time to understand the concept and even when understood, there were issues involved in identifying the Cash Generating Unit (CGU) and the determination of “Value in Use”. In practice, the exercise of identifying whether impairment has taken place stops at the initial stage itself where companies resolved that based on the initial indicators (both external and internal) there is no prima-facie evidence of any impairment. Even for auditors, the concept was difficult to apprehend and in most cases, they have accepted the decision of the management without any real independent verification.

d)            A practice that has been followed by most companies of late is the adjustment of certain expenses against reserves. Section 78 of the Companies Act permits expenses on issue of securities to be adjusted against the Securities Premium Account and most companies who incurred expenses on issue of FCCBs, etc., have resorted to this. For the purpose of taxation however, these expenses were claimed as deductible and the resultant tax saving was not being adjusted against reserves till the ICAI came out with a clarification that the tax benefit for the same also should be adjusted against the reserves.  

e)            Normally disclosures for AS is done partly in “Notes to Accounts:” and partly in “Significant Accounting Policies”. In the case of Sundaram Fasteners Ltd and Sundaram Clayton Ltd, however, the disclosure for the same is given Accounting Standard-wise from AS 1 to AS 29, which gives a clear and succinct picture at one place.

f)             Applicability of AS 29 has resulted in early or incremental recognition for many companies for liabilities which were earlier recognised as and when incurred. For example,  

Ø       Provisions for warranties are now to be done on scientific basis as against earlier method of as and when arising;

Ø       Costs of environmental damages and cleanup are now to be charged when the obligation is incurred as against as and when paid;

Ø       Provisions for reward points by credit card companies, airlines, etc are now on more scientific basis as against simple estimates;

Ø       Wage revisions, etc are now to be provided as and when the obligation is incurred as against when negotiations were actually concluded.

g)            A lot of companies in India today are undergoing restructuring by way of amalgamations, demergers, etc. A major trend emerging is that on such restructuring being carried out (which necessitates obtaining High Court approval), the revenue losses, expenses, etc are adjusted against reserves arising on such restructuring (e.g. AB Nuvo Ltd). In many cases, these losses, expenses, etc are also adjusted against revaluation reserve created on such amalgamation or demerger (e.g. Reliance Industries Ltd, Videocon Industries Ltd). Also in many cases, on such restructuring capital reserves like revaluation reserves are converted into revenue reserves, pursuant to the same being provided in the restructuring scheme which is approved by the High Court.

Concessions have been given by ICAI from 1^st April 2004 onwards to SMEs for the applicability of AS. These concessions however are mainly for the disclosure requirements rather than for recognition and measurement criteria. Inspite of these relaxations, many SMEs have difficulties in complying with a few complex Accounting Standards, and therefore prefer to have financial statements qualified rather than follow these Accounting Standards.

TRENDS/PRACTICES ON ADOPTION OF AUDITING AND ASSURANCE STANDARDS

The practices followed by auditors in implementing the AAS while conducting the audits is difficult to ascertain since such practices are not in the public domain. However, on an inquiry of the practices followed by various firms, it seems that many auditors are still not aware of the changes happening in AAS and fail to follow AAS while conducting audits. This is a dangerous trend. The members concerned can not only have problems in completing the Peer Review exercise (which requires all the AAS to be strictly followed), but can also be faced with disciplinary proceedings as he can be considered negligent in the discharge of his duties. Some other recent trends and practices noticed in adoption of AAS are enumerated below:

a)             A trend which is developing today among the mid-sized and bigger audit firms, is the practice of carrying out “Risk Based Auditing” (RBA). RBA is also gaining importance due to factors like high volume of transactions, constraints in time available, etc. This is certainly a healthy trend since RBA not only reduces the time taken to complete an audit, but also results in a better quality of audit since the concentration of the checking is only on those items where the risk of falsifying the transactions is more.

b)             Adoption of Analytical approach and the use of Computer Assisted Audit techniques (CAAT) for compliance testing to finally determine the extent of substantive testing.

c)              A trend that has developed recently is that of outsourcing of some critical areas of the audit process. This is especially done in the audit of specialised businesses like banks, etc, where the audit firm may not posses the necessary skills to evaluate the complex and automated processes followed by the auditee.

Small and Medium Practitioners (SMPs) also face a big challenge to meet the fast pace of developments in the accounting and auditing fields. The IFAC is in the process of Development of a Guide in Quality Control for use by SMPs. A similar Guide is also very essential in India since a majority of the audit firms today consist of SMPs.

Conclusion

Some of the practices highlighted above are not necessarily the best practices to be followed while complying with the Accounting Standards for preparation of financial statements or while undertaking the audit of such statements. However, it is only if one becomes aware of all practices (whether good or bad) that one can distinguish between what is good and what is bad.

To conclude, as mentioned at the recently concluded World Congress of Accountants, accountancy professionals assume a variety of responsibilities in the creation of value in both the public and private sectors. In order for the accounting profession to maintain its relevance, those involved in the accounting function should continue to adopt a more proactive, expanded role in enhancing the value creating ability of their organizations. In India, it is also time for accountants and auditors to stand up and meet this challenge so that the credibility of the profession remains intact.

STATEMENT OF ASIs ISSUED (COMPILED AS WISE)

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