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It's high time ICAI set house in order
March, 23rd 2009

A watershed incident is usually one which alters the course of events forever. Champions for improved corporate governance norms had hoped that the Satyam episode would probably turn out to be a defining moment in the history of Corporate India, a turning point that would help introduce better compliance and disclosures. What a delusion, a load of nonsense, thats been!

Soon after the Satyam episode came to light, the most indignant lot seemed to be some of the regulators. For instance, the Institute of Chartered Accountants of India (ICAI) which regulates all the auditors in the country and lays down all accounting rules and audit norms tried deflecting the blame by pointing fingers at certain firms and individuals, instead of introspecting about the quality of accounting and reporting norms that it endorses.

Sure, there is the possibility of an unholy collusion between the Satyam management and its auditors which is still the subject of an investigation by the police but in the absence of any proof, ICAI launched a broadside, through calculated leaks to the media, about the culpability of certain individuals, some of whom are important elected ICAI members and have therefore cultivated bitter rivals, eager on usurping those coveted positions.

In the meantime, the minister for corporate affairs PC Gupta also publicly lamented the lack of corporate governance in many Indian companies and dropped broad hints about how his ministry would vigorously pursue and bring to book some 100-odd companies that had violated accounting guidelines blatantly. It did not occur to him to also add that this broad-based abuse of regulations had transpired under his watch as minister over the past five years, and that they had gone unnoticed, unreported and unpunished by his ministry. Or, that these gross violations had been endorsed by numerous auditors, who remain affiliated to and licensed to practise by the ICAI. To the astute and the cynic, the outpourings seemed to have been made with an eye on the forthcoming elections, rather than with an honest intention of improving corporate governance or the state of disclosures in Corporate India.

One of the issues with India Inc that will continue to plague investors will be the extent of comfort they can draw from the published accounts and the degree to which they can trust these numbers. In this high season of righteous anger, one doubtful accounting practice continues unabated and untrammelled. This is writing off impairment to assets through the balance sheet rather than bringing it to the profit and loss account. While the bull run was rampaging through valuations, many companies used this accounting sleight to botox their revenue and profit numbers. And, minister Gupta, as well as, ICAI continue to look the other way as camouflaged corporate numbers hide losses and dupe investors.

Heres how it happens. Suppose, Company A bought 75% of Company B, which is a foreign company, about 18 months ago. At the time of acquisition, an exuberant A had paid $500 for B. But, given the economic cataclysm in the global system, Bs value today stands reduced to $100. In effect, what A bought for $500 has now become $100. How does A account for the $400 that has vapourised because of the global economic meltdown? Well, normally, best practice should have required him to deduct that amount from his net profit, or add to the loss. But, since hes in India, he does things differently he deducts the amount from the share premium reserve, an account created from the money that a company receives for issuing shares at a premium the face value is credited to paid-up share capital and the balance goes to share premium reserve. In short, the loss in the value of As investment is not reflected in the bottom line at all.

The objective of such account-brushing is to get a better reception at the fancy ball, known as the stock market. Companies relentlessly pump up revenues and profits while masking losses and brushing accounting misdemeanours under the carpet. Sure, some auditors do raise some flags, but companies are able to use the legal cracks in the system to wriggle out. In such cases, the auditors should voice their reservations loudly and clearly; the ICAI should back them with clear rules that favour investors and not audit firms that tone down their criticism for fear of losing a client. So, the issue here is: does ICAI frame rules and guidelines that eventually benefit its member firms over the interest of minority shareholders? That raises another pertinent point: should ICAI then be governed solely by elected representatives from member firms, as is the norm for all other self-regulated organisations? These questions must be answered if we are serious about corporate governance, and if we want to avoid the next Satyam.

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