The foundations of corporate law and accounting, like most other legal and political foundations in India, have been influenced by the UK system as a result of the historical links with British rule in India. International Accounting Standards have been used as a benchmark in setting accounting and reporting standards.
I shall look here at the developments in Indian accounting over the last three years, and compare existing standards with international benchmarks. Indian companies have begun to adopt various international standards, especially US GAAP, UK GAAP and IAS ('international GAAP'), in addition to presenting accounts under Indian GAAP.
The analysis in this article relates to accounting in general, and does not address the accounting and reporting requirements in specialised industries such as banking, insurance, finance, and so on.
Companies listed on the stock exchange are required to have their annual general meeting within six months of the year-end. Financial statements are filed with the registrar of companies and the Securities and Exchange Board of India. The SEBI also requires filing of quarterly unaudited financial results and interim results, accompanied by the auditors' limited review report.
Indian GAAP primarily comprises 18 accounting standards (AS) issued by the Institute of Chartered Accountants of India (ICAI). To aid interpretation, the ICAI has also issued guidance notes and 'expert opinions' on specific queries raised by companies and accountants. Of the three, however, only the standards are mandatory in application. In addition, the Indian Companies Act 1956 and various other industry-specific statutes prescribe certain minimum disclosures in the financial statements. Companies listed on the stock exchanges also need to comply with a few other accounting rules such as preparing cash flow statements and accounting for stock-based compensation.Main GAAP differences
Indian GAAP mirrors international GAAP in the key accounting principles such as going concern, consistency, accruals, prudence, substance over form and materiality. The most significant accounting differences at present are absence of consolidation and deferred tax accounting. There are other differences relating to disclosures such as segment reporting, disclosure of related party transactions, and so on. However, all these differences are expected to disappear soon with the introduction of new standards.Recent transformation
The ICAI has initiated many changes over the last three years; so, more significantly, have the companies themselves. For example, some large companies have begun to report their results of operations and financial position in accordance with international GAAP, in addition to presenting the mandatory Indian GAAP financial statements. There are several reasons for this transformation.
At the beginning of the 1990s, the Indian government initiated deregulation of the Indian economy. This was a step that attracted many foreign investors into India. Companies such as Ford, Unilever, Hyundai, Coca-Cola, McDonalds, DaimlerChrysler, ABN-Amro, Merrill Lynch, Goldman Sachs, Enron and Nokia, to name just a few, look at India as a key strategic area of operation. Multinationals not only invest in India directly but also enter into joint ventures or take significant stakes in long-established Indian companies. Examples include Ford Credit Kotak Mahindra, Prudential ICICI, Birla 3M, and so on. To facilitate consolidation with the parent company's financial statements or to facilitate understanding of the results of the Indian joint ventures in the respective home territories such as the US, the UK and Germany, Indian companies affiliated to such multinationals adopt international GAAP.
The lure of foreign capital markets has also led Indian companies to prepare accounts in compliance with international GAAP, especially US GAAP. Companies wishing to raise money on the US public markets, or merely have their shares traded thereon, need to prepare their accounts under US GAAP. The rules for a private placement in the US, however, do not require such a conversion. Companies wishing to go to the UK and Luxembourg markets either convert their accounts into IAS, reconcile from Indian GAAP to IAS or merely explain the key GAAP differences. The variety of international capital market requirements has made it necessary for Indian companies to present consolidated accounts - a new concept to the Indian reporting environment - and adopt other international GAAP requirements.
In addition, the Indian government has eased some foreign currency restrictions. One of the most significant has been the decision to allow Indian companies to reinvest their foreign initial public offering (IPO) proceeds abroad. This has encouraged many Indian companies to invest in the US and Europe, inevitably leading to the adoption of US GAAP, UK GAAP and IAS.
For all these reasons, many Indian companies now publish their financials under US GAAP and other international GAAP as an integral part of their annual report. Indian companies that have registered with the US SEC include Infosys Technologies, Satyam Infoway, Silver-line Technologies, ICICI, ICICI Bank and VSNL. Many other companies are expected to tap international capital markets in the years to come.
An excellent example of companies adopting global reporting requirements is the Infosys annual report. Infosys presents its accounts in substantial compliance with eight different international GAAPs, in the respective languages!
US GAAP is currently the preferred international GAAP among Indian companies. This is more by necessity than because of a specific preference - capital market money and investment opportunities are more abundant in the US today than in all other markets put together. The future, however, could tell a different story as market access improves in Europe and elsewhere and as IAS improves its influence as a globally acceptable body of standards.Moving closer to global standards
The ICAI continuously addresses issues relating to better accounting and reporting. A new standard, AS 16, Borrowing Costs, aligns Indian accounting with international GAAP. It requires adoption of the avoidable cost concept in determining the amount of interest that can be capitalised. Also, AS 17, Segmental Reporting, and AS 18, Related Party Disclosures, will be applicable soon. Other standards in the pipeline include accounting for leases, earnings per share, consolidation, deferred tax, construction contracts, and so on.
There is thus clear evidence that the ICAI is moving fast to bring Indian accounting on a par with the rest of the developed countries and make it more amenable to analysis by foreign investors and analysts.
Thus, although Indian GAAP differs fundamentally in certain respects from international GAAP, it is taking steps to move closer to global best practices. Therefore, it is worth saying 'watch this space'.
Ram Iyer, BCom (Bombay); ACA (England and Wales); ACA (India); CPA (US); ATT (London).
Key differences between Indian GAAP and international GAAP
There are many GAAP differences, but some of the more prominent ones are briefly explained below. References in brackets are to the key literature in Indian GAAP. Although the following paragraphs describe the GAAP differences as they currently exist, the reader should bear in mind that the ICAI is currently preparing several new standards that will eliminate some of these differences in the next year or two. Other regulatory bodies such as the SEBI and the Reserve Bank of India are also making significant contributions in this direction.Accounting
Consolidation, equity accounting and business combinations. The absence of both consolidation and equity accounting in Indian GAAP is the most significant GAAP difference. The parent company's holding in each subsidiary is required to be disclosed along with the separate accounts (not consolidated) of each subsidiary. There is no requirement to eliminate inter-company transactions. The investor recognises its share of the investee's earnings only when the investee declares dividends, ie, when the earnings are distributed rather than when the profits are earned. Indian tax law, too, does not recognise consolidated results. Accounting for acquisitions and mergers is governed by AS 14, Amalgamations, which lays down conditions for pooling and acquisition accounting. However, a business combination can lead to different results when international GAAP is applied.
Deferred taxation. As there is no accounting standard on the subject, deferred tax accounting is absent in India except in the accounts of a few multinationals. Companies only account for the tax provision based on the current tax law. Consequently, there is also no requirement for companies to reconcile their effective and statutory tax rates in the financial statements.
Leased assets. Leases that, in substance, qualify as capital leases are internationally required to be accounted for differently from operating leases. Indian GAAP does not require this differentiation. Thus, capital leases continue to remain on the lessor's balance sheet and stay outside the lessee's balance sheet.
Depreciation (AS 6 and Sch XIII of the Companies Act). AS 6, Depreciation Accounting, requires depreciation to be allocated over an asset's useful life, a requirement similar to that under international GAAP, and the Companies Act reinforces this by prescribing minimum rates of depreciation.
Pre-operative expenditure (AS 10 and guidance note). AS 10, Accounting for Fixed Assets, prescribes capitalisation of costs until an asset is ready for its 'intended use', a term also used in international GAAP literature. A guidance note on expenditure incurred during the construction period provides practical guidance on the subject and allows the captitalisation of expenditure during the 'trial run' phase of asset construction. However, there can be practical differences in interpretation of the term 'intended use' between Indian GAAP and international GAAP.
Revaluation of assets (AS 10). Indian GAAP, like UK GAAP and IAS, allows the revaluation of property, plant and equipment, while US GAAP does not allow revaluation.
Foreign currency transaction differences (AS 11). AS 11, Accounting for the Effects of Changes in Foreign Exchange Rates, requires the capitalisation of exchange differences arising on repayment of liabilities incurred for the purpose of acquiring fixed assets even after the asset is put to use. International GAAP does not allow such foreign currency transaction differences to be capitalised. As a result, significant foreign exchange differences that are expensed under international GAAP are capitalised under Indian GAAP.
Valuation of investments (AS 13). AS 13, Accounting for Investments, requires current investments to be carried at the lower of cost and fair value and long-term investments at cost, except for other than temporary declines in values. The aggregate market values of quoted long-term investments are required only to be disclosed, not adjusted, whereas international GAAP allows, and in some cases requires, long-term investments to be marked to market.
Revenue recognition (AS 9). AS 9, Revenue Recognition, requires revenues to be recognised when significant risks and rewards of ownership are transferred and no significant uncertainty exists over collection. This requirement is similar to international GAAP. However, revenue recognition comes under particular scrutiny when companies prepare their accounts under US GAAP, because of its numerous rules for specific situations.
Stock-based compensation. Although there is no accounting standard on this subject, the SEBI has issued the Employee Stock Option Scheme and Employee Stock Purchase Scheme Guideline, 1999, which requires listed companies to recognise compensation costs using either the intrinsic value method or the fair value method. Although the guidelines are brief, they tally broadly with the approaches specified in US GAAP and UK GAAP for fixed plans.
Research and development expenditure (AS 8). AS 8, Accounting for Research and Development, requires the deferral of costs that meet certain criteria that are similar to the requirements under UK GAAP and IAS. However, a different picture could emerge if accounts are prepared under US GAAP, which generally requires all research and development costs to be expensed as incurred.
Derivatives. There is currently no standard on derivatives or hedge accounting in Indian GAAP other than AS 11, which deals with foreign currency transactions. The main reason for a lack of literature is that trading in derivatives is prohibited in India except in a few areas, including the recent introduction of trading in index futures.Disclosures
Disclosures in Indian GAAP are primarily driven by the requirements of the Indian Companies Act and accounting standards.
Related party disclosures. The Companies Act requires limited disclosures on certain transactions with directors, and the ICAI has just issued a new standard, AS 18, Related Party Disclosures, which comes into effect in respect of accounting periods commencing on or after 1 April 2001. Thus, while this is currently an important disclosure difference, it is expected to be bridged soon in Indian GAAP financial statements.
Extraordinary items (AS 5). Although the jargon differs, AS 5, Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies, defines extraordinary items in terms similar to IAS and US GAAP. However, differences in interpretations can lead to some items being displayed differently under Indian GAAP and international GAAP. Examples include adjustments to estimated tax provisions made in earlier years, and exceptional items such as voluntary retirement costs (commonly known as VRS costs).
Prior period items (AS 5). Unlike in UK GAAP and US GAAP, AS 5 does not require the restatement of comparatives to account for accounting errors; the adjustment is required to be made in the current year with disclosures of the prior period amount. However, the AS 5 requirement complies with IAS, which allows rather than requires restatement of comparatives.
Contingencies (AS 4). AS 4, Contingencies and Events Occurring After the Balance Sheet Date, has definitions and disclosure requirements broadly similar to those in international GAAP.
Segmental disclosures and discontinued operations. Segmental disclosures will be enforced through the new standard, AS 17, Segment Reporting, which comes into effect in respect of accounting periods commencing on or after 1 April 2001. This is another disclosure difference that will disappear soon.
Retirement benefits (AS 15 and Sch VI of the Companies Act). Disclosures include stating the accounting policy under AS 15, Accounting for Retirement Benefits in the Financial Statements of Employers, and the amount of contribution and provision made for retirement benefits under Sch VI of the Companies Act. International GAAP requires more extensive disclosures including the key actuarial assumptions, the annual movement in the retirement benefit obligation and the funded status of the plan assets.
Earnings per share. While a new eps standard is expected, there is currently limited guidance on dealing with complex capital structures, unlike in international GAAP, which prescribes detailed rules for various complications such as weighted average shares, warrants, convertible debt, stock options, anti-dilutive effects, and so on.
Dividends. Under Indian GAAP, dividends are accounted for by the paying company when proposed, which tallies with UK GAAP and IAS but differs from US GAAP where dividends are generally accounted for only when declared.
Fair value disclosures of financial instruments. AS 13 requires disclosure of long-term investments' market values. However, there is no requirement to disclose fair values under Indian GAAP for other instruments such as loans and financial hedges. International GAAP requires fair value disclosures of all financial instruments and also provides guidelines on the methods that can be used to compute the fair values.
Statement of cash flows (AS 3 and clause 32 of SEBI listing agreement). Although AS 3, Cash Flow Statements, allows the direct and indirect methods, the SEBI regulations allow only the indirect method, unlike international accounting, which allows either method. Although some differences exist in classification and non-cash disclosures, Indian cash flow statements look broadly similar to those prepared under international GAAP.
Quantitative disclosures (Sch VI of the Companies Act). The Companies Act requires disclosures about the quantity and value of goods produced, sold and in stock, analysed between the key product lines. This provides the reader with some useful information about the nature of the business, although the information is purely quantitative, not descriptive. International GAAP does not require such disclosures.
Non-financial statement disclosures. In the US, an annual filing with the SEC requires extensive disclosures about the business, properties, legal proceedings, market information, management's discussion and analysis of operation, directors, executive compensation, key shareholders and significant contracts. None of these is required in annual filings in India. However, the directors' report is a statutory requirement that briefly explains the performance and key developments during the year. Additionally, some listed companies have already begun to describe compliance with the SEBI code of corporate governance, which becomes mandatory for some listed companies in 2001.