Companies prepare financial statements for reporting to shareholders, regulators, tax authorities, and other stakeholders such as bankers and lenders. The statements are prepared in accordance with the accounting standards issued by the Institute of Chartered Accountants of India, and notified by the Ministry of Corporate Affairs. However, there are several other factors that are increasingly influencing the financial reporting process.

role of regulators

Recent decisions by various regulators that will impact financial reporting include:

MCA notification permitting capitalisation of additional foreign exchange differences;

MCA amendment permitting amortisation of certain intangible assets related to toll road ‘Build-Own-Operate-Transfer’ contracts, based on the pattern of projected revenues;

Provisions in the proposed Companies Bill requiring mandatory preparation of consolidated financial statements and restatement of financial information in certain circumstances (such as occurrence of fraud);

Decision by the Securities and Exchange Board of India to set up a review mechanism for qualified audit reports filed by listed companies, which may result in restatement of financial statements;

Current and proposed guidelines issued by the Reserve Bank of India that will impact financial reporting by banks and non-banking finance companies in areas such as provision for loan losses;

Proposed issuance of Tax Accounting Standards by the Central Board of Direct Taxes for computation of income.

While some amendments (such as those related to consolidated financial statements, qualified audit reports and restatement) are aimed at improving the quality of financial reporting, others (such as capitalisation of foreign exchange losses and amortisation of toll road intangibles) are aimed at providing relief to companies, or addressing regulatory or fiscal requirements. Furthermore, while some amendments are geared towards ensuring stringent compliance with accounting standards, others provide companies with choices that may be in conflict with existing standards. Regardless of the intent, regulators will likely have a growing influence over the preparation and reporting of financial information.

role of market participants

While it is routine for the investor, analyst, and media communities to review financial results for performance trends, there is also greater focus on the accounting and reporting policies and practices of companies. These may include benchmarking practices with other leading companies within the peer group, scrutiny of practices to determine whether they are excessively aggressive, or evaluating the likely impact from transition to internationally accepted practices such as International Financial Reporting Standards.

Recent media reports have raised concerns over the aggressive accounting policies followed by certain companies, highlighted the common areas of accounting misuse and, in the process, identified companies that may be following such practices.

The emergence of proxy advisory firms (prevalent in developed markets) in India has also stepped up the scrutiny of financial information released by companies. These firms advise investors on voting for or against resolutions at general meetings, and often publish their analysis on the corporate governance levels in various listed companies. This empowers both institutional and retail shareholders with information and views, based on which they may raise concerns at general meetings, or vote on important resolutions. While the proxy advisory firms have so far focused on issues such as restructuring or acquisitions, executive compensation, funding, related party transactions, and auditor independence, they are likely to focus more on accounting and reporting practices in the near future. This is consistent with their approach in the developed markets.

To dos

Companies should keep in mind the enhanced regulatory and market participant scrutiny when preparing and reporting financial statements. This may include benchmarking policies and practices with local and international peers, and transitioning to policies that find greater acceptability among regulators and market participants. Companies may also need to address their auditor’s qualifications more proactively. Furthermore, they should continually evaluate the impact of emerging regulations. Lastly, financial reporting should transform from an annual or quarterly exercise of compiling statements based on statutory accounting standards, to an ongoing, dynamic process of managing communication and the expectations of all stakeholders.

(Jamil Khatri is Global Head of Accounting Advisory Services, KPMG in India)

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