565

THE CHARTERED ACCOUNTANT

THEME

Augmenting Economic Governance

through Accountancy Excellence
CA. Manoj Fadnis
Past President ICAI and CAPA
The corporate governance framework is linked to ‘transparency’
either directly or by implications. The public demand for greater
‘transparency’ became shriller with every corporate fraud
around the globe. As the corporate frauds centred around the
financial statements containing material misstatements, without
audit qualifications, the accounting practices and the auditors’
independence naturally came under deeper scrutiny. For the
corporate structure to exist and grow it is imperative that the
users of the financial statements must have confidence and
trust in the financial performance and the financial position
being reported to them. The current market capitalization on the
NSE1 is Rs 30,899,396.78 crores or US $3.72 Trillion. With so
much at stake, the financial and increasingly, the non-financial
information contained in the financial statements need to be not
only timely and relevant but also meet the expectation of the
large universe of the users.

T
he legal and the regulatory
response followed the
corporate frauds. The
US introduced the Sarbanes
Oxley Act in 2002 to improve the
auditing and public disclosure in
response to several accounting
scandals in the early 2000s.
In UK the Financial Reporting
Council was established with
the objective of restoring trust in
audit and corporate governance.
In Australia, the Corporate Law
Economic Reform Program (Audit
Reform & Corporate Disclosure)
Act 2004 came into effect from
1st July 2004. Several regulatory
reforms took place in India which
culminated in The Companies
Act, 2013 being implemented with
effect from 1st April 2014.
One common thread amongst
all these reforms has been the
emphasis on transparency in
the financial statements and
adherence to the accepted
1
As on 23rd October 2023 -NSE website
2
Objectives, usefulness and limitations of general purpose financial reporting as per the Conceptual Framework of Financial Reporting
under Indian Accounting Standards (Ind AS) issued by the ICAI.
global accounting benchmarks.
With the exception of the US, the
major economies have accepted
the International Financial
Reporting Standards (IFRS)
as issued by the International
Accounting Standards Board
(IASB) as the basis for the
financial reporting.
The objective2 of the general
purpose financial reporting is
to provide financial information
about the reporting entity that is
useful to existing and potential
investors, lenders and other
creditors in making decisions
relating to providing resources
to the entity. Those decisions
involve decisions about (a)
buying, selling or holding
equity and debt instruments;
(b) providing or settling loans
and other forms of credit; or
(c) exercising rights to vote
on, or otherwise influence,
management’s actions that affect
the use of the entity’s economic
resources.
The neutrality of the financial
reporting between the existing
and the future stakeholders is
an important characteristic.
Given the quarterly reporting
by the listed enterprises,
the management is likely to
be in pressure to show the
performance on a quarter-to-
quarter basis. The concept
of continuous disclosures of
material events to the stock
exchanges only adds to this
pressure. However, the uniformity
and the consistency in selection
of the accounting policies
ensures that the management
discretion does not override
the long-term objectives and
succumb to the short-term
pressures.
The financial statements are
required to describe how
efficiently and effectively the

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THEME
entity’s management and
governing board have discharged
their responsibilities in using the
economic resources available
to the entity. The claims against
the entity is also an important
information sought for by the
stakeholders to evaluate the
performance and therefore,
requires to be properly reported.
The accounting frauds exploit
the grey areas in accounting.
It is imperative these areas
are minimised, and the
best accounting practices
are codified. Intangible
assets, contingent liabilities,
accounting of derivatives
are some of the examples
where the improvement in
accounting requirements, as
per the applicable accounting
standards, have resulted in
more accountability and better
governance. The disclosures of
related party transactions have
led to more questioning of the
management on these issues
and has attracted more attention
of the regulators.
The differences between the
intangible items and intangible
assets are now well settled.
While all intangible assets are
intangible items, the reverse
is not true. Recognising large
expenditure as deferred revenue
expenditure and amortising
it over a few years was a
common practice. In fact, the
Schedule VI to the Companies
Act, 1956 till 2011, permitted
the classification of the
miscellaneous expenditure to the
extent not written off or adjusted
under the heading of ‘Assets’
in the balance sheet. Thus, it
was an accepted position for
the corporates to write off large
revenue expenditure such as
advertisement etc.. over a period
of few years but at the same
time claim it is an expenditure
under section 37 of the Income
3
Order no WTM/AB/CFID/CFID_1/20686/2022-23 dated 21st October 2022
22 NOVEMBER 2023
Tax Act for the purpose of
computation of taxable income.
The revision of Schedule VI in
2011 and presently the Schedule
III to the Companies Act 2013
permit the Accounting Standards
to become the basis for the
preparation and presentation of
the financial statements. As a
result, the principles enunciated
in AS 26/Ind AS 38 will not
permit capitalization of revenue
expenditure and the subsequent
amortization over a period
of time but will require such
expenditure to be charged to the
statement of profit and loss.
The accounting standards are
principle based. The definitions
of terms may be more specific
under the law but will be broader
under the applicable accounting
standards. The terms used in the
law will apply for the all the legal
and regulatory purposes whereas
the definition of the same term
as per the accounting standard
will apply for the purpose of the
financial statements.
The term “key managerial
personnel” (KMP) is defined
in sub-section (51) of section
(2) of the Companies Act,
2013 (the Act) to mean (i) the
Chief Executive Officer or
the managing director or the
manager; (ii) the company
secretary; (iii) the whole-
time director; or (iv) the Chief
Financial Officer. The term
‘manager’ is defined under
sub-section (53) to mean an
individual who, subject to the
superintendence, control and
direction of the Board of
Directors, has the management
of the whole, or substantially
the whole, of the affairs of
a company, and includes
a director or any other person
occupying the position of a
manager, by whatever name
called, whether under a contract
of service or not.
THE CHARTERED ACCOUNTANT
As against this the Accounting
Standard 18 Related Parties
defines it as those persons
who have the authority and
responsibility for planning,
directing and controlling the
activities of the reporting
enterprise. Similarly, Ind
AS 24 defines it as those
persons having authority and
responsibility for planning,
directing and controlling the
activities of the entity, directly or
indirectly, including any director
(whether executive or otherwise)
of that entity.
The definition of the ‘manager’
under the Act is very wide. A
person may not fall within the
definition of the ‘manager’ but
may be covered as a KMP
under the applicable accounting
standards. Independent
Directors are not covered within
the definition of the KMP under
the Act and AS 18 whereas
they are not excluded as per
Ind AS 24. Interestingly Ind AS
24 includes ‘domestic partner’
within the definition of close
members of the family who are
expected to influence a related
party. Given the changing
social scenario, the importance
of such inclusions cannot be
underestimated.
The disclosures of the
transactions with the KMPs, their
relatives and entities privately
controlled by the KMPs adds
a lot of value to the financial
statements. The requirement
to disclose these transactions
results in higher responsibilities
on the audit committees while
approving and ensuring the same
to be at arm’s length.
The interpretations of the
Accounting Standards is gaining
more importance with the
regulators taking strict action.
SEBI3 barred a well reputed
listed company as well as
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THE CHARTERED ACCOUNTANT
its promoters from the stock
market for two years, for
fraudulent misrepresentation
of the company’s statements.
However, the order has been
stayed by the Securities
Appellate Tribunal (SAT). Thus,
the matter is sub-judice. The
issues involve interpretation of
the then applicable accounting
standards. The said company
had real estate revenue as a
significant constituent of the
total revenue. The real estate
business had entered into sale
agreements with an unlisted
company in which the employees
of the listed company were the
directors. It was alleged that
the said directors were under
the control of the management
of the listed company. Also,
another allegation was that the
shareholding pattern of the
unlisted company was such that
the majority was held by the
listed company and its promoters
indirectly. If so, the transactions
were between the related
parties and should have been
disclosed accordingly. Further,
sale arrangements with the
unlisted company were alleged
to be not genuine and the profits
from such transactions were
unreal. The early outcome of the
litigation will be useful.
With the growth in the corporate
sector, the corporate groups
have also increased manifold.
A group includes subsidiary,
associate and a joint venture.
An entity has control over
a subsidiary and therefore
line by line consolidation is
mandated. As against this, in
case of an associate the investor
has significant influence and
therefore, the equity method
of accounting is permitted. Ind
AS 110 lays down elaborate
principles for the consolidation
of a subsidiary. It defines
4
WTM/ASB/CFID-SEC4/25452/2022-23 dated 31st March 2023
5
IASB Chair Andreas Barckow at the IFRS Foundation Conference: Communicating
with investors in uncertain times.
www.icai.org
the principle of control and
establishes control as the basis
for consolidation. It also sets
out how to apply the principle
of control to identify whether an
investor controls an investee and
therefore must consolidate the
investee.
The issue whether an investee
should have been consolidated
as a subsidiary or as an
associate came before SEBI
recently. SEBI4 held that the
company had wrongly classified
a particular company as an
associate and not as a subsidiary
and accordingly the consolidated
financial statements were not
as per the provisions of Ind AS
110 resulting in the financial
statements not showing true and
fair view. This order is also under
appeal before the SAT and thus
the case is sub-judice.
The ultimate outcome of the
litigation may take time. But such
cases highlight that governance
practices are important in
selection of the accounting
policies and aggressive
interpretations need to be
avoided.
The Accounting Standards have
evolved over a period of time.
Today there are two sets of
accounting standards – the first
set is, the Accounting Standards
(AS) which are applicable to
smaller entities and the second
set is, the Indian Accounting
Standards (Ind AS) which are
applicable to the listed and
entities with net worth more than
rupees two hundred and fifty
crores. Banks and insurance
companies are still to migrate to
Ind AS.
The Ind AS are converged with
the IFRS, have greater emphasis
of economic substance over legal
form, recognise time value of
567
THEME
money and have greater usage of
fair value. It is said that fair value
is relevant while the historical
cost is reliable. The trade-off
is thus, between reliability and
relevance. In case of financial
assets and liabilities, the fair
value basis of measurement
is more relevant than the age-
old historical cost concept.
Derivatives require minimum
initial investment but the outcome
on their settlement can be far
greater. Measuring the derivatives
at historical cost will be irrelevant.
They have to be measured at
fair value. Keeping pace with the
changing business complexities,
the Indian Accounting Standards
are more in line with the needs of
the present times.
The financial reporting too has
its limitations. They are not
designed to show the value of a
reporting entity; but they provide
information to help existing and
potential investors, lenders and
other creditors to estimate the
value of the reporting entity.
It is acknowledged that the
use of accounting estimates
is a limitation of the financial
statements, but this does not
make the financial statements
less reliable.
Markets5 rely on trust. Investors
need to trust the markets, to
trust the companies. And trust,
in turn depends on all players
communicating transparent
and useful information. This is
particularly true and important in
times of heightened uncertainty.
Good governance and good
accounting will always go hand
in hand. Corporates following the
accounting principles in letter
and spirit will be richly rewarded
by the market and those who do
not, need rightly to be punished.

Author may be reached at
eboard@icai.in
NOVEMBER 2023 23