Reporting close to international practices

Companies Bill 2012 will have a wide-ranging impact on Indian companies in terms of governance requirements, investor rights, and financial reporting.

Consolidated statements

Companies with one or more subsidiaries will have to prepare consolidated financial statements. Currently, only listed companies have to file them under the listing agreement. Furthermore, many companies that have associates or joint ventures do not prepare consolidated statements, as they do not have subsidiaries. It is likely that such companies too will have to prepare consolidated statements.

Revision of statements

The Bill permits reopening and restating the financial statements of a company, on an order passed by a court or tribunal, if the accounts were prepared in a fraudulent manner or the company’s affairs were mismanaged. A restatement may be approved when applied for by a statutory or regulatory authority such as SEBI or the Income Tax Department. A company may also voluntarily apply for restatement if, according to the directors, the accounts do not comply with accounting standards or other requirements of the Bill.

This change is consistent with international practices — currently, Indian companies have to rectify any errors relating to a previous year only by making a ‘prior period adjustment’ in the current financial statements. Revision of financial statements will enable users to understand the impact of such errors or frauds during each of the past periods.

Depreciation

The Bill prescribes useful lives over which fixed assets are required to be depreciated, and these useful lives are different from those currently applicable under Schedule XIV of the Companies Act. In most cases, the useful lives prescribed will result in a higher depreciation. However, the Bill permits companies to exercise judgment and depreciate assets using lower rates if the useful life of the asset is longer than that prescribed by the Bill.

In such cases, a company will have to disclose the reasons that justify the longer useful life. Furthermore, the Bill also provides for component accounting, by stating that assets with components that have a different useful life should be depreciated separately. This brings the depreciation requirements in India in line with international practices.

redemption of debentures

Currently, companies are permitted to charge premium related to redemption of debentures directly against the share premium account, thereby avoiding a charge to earnings.

This results in under-reporting the true cost of debt. Under the Bill, for prescribed classes of companies, the securities premium account may not be utilised to provide for premium payable on redemption of debentures, which will have to be provided out of the company’s profits.

Amalgamation schemes

Historically, several companies have used court-approved amalgamation schemes to achieve accounting results that are not aligned with accounting standards. Under this approach, companies either charge goodwill or other non-recoverable assets against the reserves, or establish specific reserves for charging future expenses and losses. This often results in under-reporting expenses and over-reporting profits.

The Bill now asks auditors to certify that the accounting treatment used for schemes of arrangement or amalgamations complies with accounting standards. This is similar to SEBI’s requirement for listed companies, and extends it to all amalgamation schemes.

Even though the above provisions will improve financial reporting, several clarifications are needed. For example, the definition of a ‘subsidiary’ and ‘associate’ under the Bill are different from those under accounting standards. It should be clarified that the consolidated financial statement will be prepared using definitions in accounting standards and not those under the Bill.

Furthermore, internationally, intermediate holding companies are exempt from preparing consolidated financial statements if the ultimate holding company prepares/ files them. The Bill does not contain any such exemption, and may result in undue effort without significant benefits. For amalgamation schemes, there should be guidance on whether reserves established under previous schemes can be used to adjust expenses/ losses after the Bill comes into effect.

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

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