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Updated: September 19, 2010 19:45 IST

From ‘true and fair’ to ‘fair’

D. Murali
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To those who are implementing IFRS (the International Financial Reporting Standards), training is a big challenge, feels S. Sundararaman, Partner, Haribhakti & Co, Chartered Accountants, Chennai (http://bit.ly/F4TSundararamanS). More specifically, training in an environment of dynamic evolution of the standards is the challenge, he adds, during a recent interaction with Business Line. “Finding adequate human resources for this is a bigger task.”

Apart from the HR angle, what is imperative in the implementation of IFRS is to understand what the financial statements would look like post implementation, observes Sundararaman. For this, he advises every company implementing IFRS to closely interact with its industry association, valuation experts, actuaries and experts from other fields so as to understand the impact of fair valuation on various items in its financial statements.

“Let us take the case of tea companies. Valuation of tea bushes and its impact on financial statements in the year of implementation and the long-term impact of adoption of such value on the future financial statements are to be studied before taking a call on the methodology to be adopted in the year of implementation of IFRS.”

Excerpts from the interview.

With the move towards IFRS not too far away, how do you view the transformation process impacting the auditing profession?

The biggest change for the auditing profession on the impending move to IFRS could be summed up as a shift in emphasis from ‘true and fair’ to ‘fair.’ This shift could be explained by an analogy. If a person looking at my neck is to ask me, ‘What are you wearing?’ I would say ‘A red necktie.’ Here, ‘necktie’ is the truth and ‘red’ is a fair description.

Similarly, whether an item in financial statement is to be grouped under ‘sundry debtors’ or ‘loans and advances,’ or an item is to be grouped as ‘deposit’ or ‘creditor’ is covered by the description ‘true’ and the value at which this is to be stated is ‘fair.’

The implementation of IFRS would require the auditing profession to focus more on the valuation of the items of financial statements than on the classification of the item since IFRS divides financial statements into broad heads and does not toothcomb the items of financial statements.

In this process, the profession has to learn new concepts and bring them into practice; at the same time, the profession may have to unlearn some of the concepts and discontinue some of the practices.

The profession has in a way been prepared for this since the introduction of the revised AS-15 on employee benefits and AS-28 on impairment of assets. Both these standards require the company and the auditor to make professional judgments on many issues including on forecasting future events which till recently the accounting profession was not used to or, if one may say so, which was abhorred by the profession.

This is a paradigm shift for the profession, from reporting on the financial statements to passing judgments on the financial statements, because many issues relating to adherence to IFRS require subjective judgments. The profession has been certifying the financial statements based on past events, with very few matters on the basis of likely future events. This has to change, and in that sense the transformation is literally from the past to the future.

Since valuation is an important cog in the wheel of IFRS implementation, how do you see the various aspects in the field of valuation evolving?

Valuation is to IFRS implementation what book-keeping is to accountancy. Valuation is a specialised field. And with complex products and transactions swarming the investment bazaar there is a huge demand for trained experts.

There are actuaries specialising in certain fields of valuation such as pension, insurance and employee benefits; there are other fields of valuation which require other professionals such as engineers. But in all these valuations, accountants would be required to evaluate and examine the approach and methodology of valuation apart from acting as experts in the field of valuation of investments and financial instruments.

Valuation per se has evolved from a mechanical mathematical calculation of past events to building mathematical models for forecasting future cash flows, predicting discount rates and growth rates, deciding on the right approach, and applying the right methodology to arrive at a value.

Can you outline a few regulatory and other issues related to valuation?

Valuation the world over has undergone a sea change from being a regulation-driven activity to an approach-driven activity. Valuation as a stream of professional activity requires institutionalised regulation and standardisation, as in the US by AICPA (the American Institute of Certified Public Accountants) which has prescribed valuation standards.

Till recently, we all were following the methods prescribed by the erstwhile Controller of Capital Issues till the Reserve Bank of India mandated the pricing of shares on discounted free cash flow method in the case of allotment or transfer of shares to foreign investors.

Even this method, though considered widely acceptable, could not be used as a one-size-fits-all approach. Start-up companies and companies sourcing investment from VC (venture capital) and PE (private equity) funds, find adoption of such rigid upfront valuation extremely impracticable.

An approach to valuation is primarily contextual and requires application of a good amount of professional judgment. Professional pronouncements and standards lend credibility to the exercise as against regulatory mandates prescribing specific approaches and methods without situational discretions. I visualise a lot of professional and regulatory activity in the field of valuation once the dust settles down on the convergence of Indian Accounting Standards with IFRS.

Apart from IFRS, what other major developments in the corporate world are of interest to the accounting profession currently?

These are exciting times and the agenda for today’s accountant can be hectic. We have the Direct Taxes Code introduced in Parliament, the imminent introduction of GST (goods and services tax) law, new company law to be introduced in Parliament after vetting by the Standing Committee, and the topic we have been discussing today, the implementation of IFRS.

Some of the topical tax-related judicial decisions with far-reaching impact have also caught the attention of the profession. The recent Supreme Court decision in the case of GE India Technology Centre Private Ltd is a landmark decision with likely relief for companies hit by the Vodafone decision. This decision of the apex court has saved the corporates from standing in the queue before the Income Tax Department for every foreign remittance.

Companies hit by the Vodafone decision could also look at the DTAA (double taxation avoidance agreement) with respective countries since the Supreme Court has reiterated the primacy of DTAAs even in the case of deduction of tax at source.

**

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