The Institute of Chartered Accountants of India (ICAI) has always had the reputation of being conservative. Therefore, it did come as a shock when it made an announcement regarding derivatives which made the already-beleaguered bourses nosedive.
In addition, corporates lured by big money in exotic derivatives, have filed cases against their bankers questioning why they should bear losses for having heeded the advise given by banks. In this situation, courtesy the sub-prime crisis, the announcement was least expected.
Adding to confusion
The notification from the ICAI, a first from the body which specialises in accounting and auditing standards, has further added to the confusion. The notification basically advances the date for implementation of AS-30 Measuring Financial Instruments from 2011 to 2008.
The ICAI encourages early application of its accounting standards, but companies seldom do so unless the compliance is made mandatory. There is a clear segregation of all accounting standards issued by the ICAI those that relate to measurement and to disclosure.
Companies usually do not mind applying a disclosure standard early since they make a number of disclosures anyway. But applying a measurement standard, such as AS-30, is generally not-so-readily done .
To be fair to the corporates crying foul now, the ICAI kept AS-30 in the development and draft stage for too long for anyone to take serious notice. How much of a legal implication this notification has could also come into question.
The ICAI should have advanced the date of complying with AS-30 itself from 2011 to 2008 instead of relying on a notification which one could liken to a Guidance Note gives guidance but not necessarily to be followed.
Auditors, in their report, talk about Accounting Standards prescribed by Section 211 of the Companies Act, 1956. Although the Section 211 blesses all the accounting standards issued by the ICAI, it does not necessarily have to embrace a notification issued.
Another reason for the ICAI to have made AS-30 mandatory from 2008 itself, if it wanted to mark-to-market (MTM) all derivative contracts, is the concept of fair value. After the issue of AS-28 on intangibles and AS-29 on provisions and contingencies, and also considering the International Financial Reporting Standards (IFRS) norms, MTM and fair value are but two sides of the same coin. IFRS norms talk of fair value at the every available opportunity.
AS-30 also exhorts the principle of fair value save for trade receivables and held-to-maturity investments. Even if corporates had waited till 2011 to adopt AS-30, the losses could have hit them at any point during the intervening period.
While there is an argument that there could have been profits too, the recent example of Societe Generale proves that once there are profits, corporates only strive for more which turns out to be a disaster.
When the entire balance sheet is measured at fair value, it would not be in the fitness of things to have a different treatment for exotic derivatives. The argument against fair value is that it is difficult to assign a value to instruments such as derivatives and sub-prime assets.
This argument can be refuted by taking a look at fixed assets they are normally valued at cost less depreciation but marked to market once it is know that the asset or a group of assets are impaired.
Make them mandatory
The ICAI has created enough of a furore by issuing this notification. It should logically follow this up by making AS-30, AS-31 and AS-32 mandatory with effect from April 1, 2008.
This would not only end the present imbroglio, but would also mean taking a few more confident steps towards compliance with IFRS, which the ICAI has mandated from 2011 onwards.
For small and medium enterprises which take the brunt of this standard, it would be better to accept the current reality rather than be unduly optimistic that 2011 will be better.
Mohan R. Lavi (The author is a Hyderabad-based chartered accountant.)