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Liabilities - Tax Deferred Liabilities A deferred tax liability occurs when taxable income is smaller than the income

reported on the income statements. This is a result of the accounting difference of certain income and expense accounts. This is only a temporary difference. The most common reason behind deferred tax liability is the use of different depreciation methods for financial reporting and the IRS. A deferred tax asset is the opposite of a deferred tax liability. Deferred tax assets are reductions in future taxes payable, because the company has already paid the taxes on book income to be recognized in the future (like a prepaid tax). Deferred tax liability 1. Book basis - tax basis of asset or liability = cumulative temporary difference (cumulative temporary differences x enacted tax rate). 2. Scheduling of future taxable amounts. Deferred tax asset 1. Book basis - tax basis of asset or liability = cumulative temporary difference (cumulative temporary difference x enacted tax rate). 2. Scheduling of deductible amounts. Advertisment - ExamPrep continues below. The Liability Method of Accounting for Deferred Taxes. There are several different tax-allocation methods: Deferred Method The amount of deferred income tax is based on tax rates in effect when temporary differences originate. It is an income-statement-oriented approach. It emphasizes proper matching of expenses with revenues in the period when a temporary difference originates. Finally, it is not acceptable under GAAP. Asset-liability Method The amount of deferred income tax is based on the tax rates expected to be in effect during the periods in which the temporary differences reverse. It is a balance-sheetoriented approach. It emphasizes the usefulness of financial statements in evaluating financial position and predicting future cash flows. Most importantly, it is the only method accepted by GAAP. Implications of Valuation Allocation A deferred tax asset is a reduction in future cash outflow (taxes to be paid). But, the asset has value only if the firm expects to pay taxes in the future. For example, an Net Operating Loss (NOL) carry-forward is worthless if the firm does not expect to have positive taxable income for the next 20 years. Since accounting is conservative, firms must reduce the value of their deferred tax assets by a deferred tax-asset valuation

allowance. This is a contra-asset account CR (credit) balance on the balance sheet - just like accumulated depreciation or the allowance for uncollectible accounts) that reduces the deferred tax asset to its expected realizable value. FXCM -Online Currency Trading Free $50,000 Practice Account Increasing the valuation allowance increases deferred income tax expense; decreasing the allowance does the opposite. Changes in the allowance affect income tax expense. Although the need for an allowance is subjective, its existence and magnitude reveals management's expectation of future earnings. Management can use changes in the allowance to "manipulate" NI by affecting income tax expense. Analysts should scrutinize these types of changes. Deferred Tax Liability Treatment If a tax asset or liability is simply the result of a timing difference that is expected to reverse in the future, it is best classified as an asset or liability. But if it is not expected to reverse in the future, it is best qualified as equity. Deferred tax liabilities that should be treated as equity in the following circumstances: 1. A company has created a deferred tax liability because it used accelerated depreciation for tax purposes and not for financial-reporting purposes. If the company expects to continue purchasing equipment indefinitely, it is unlikely that the reversal will take place, and, as such it should be considered as equity. But if the company stops growing its operations, then we can expect this deferred liability to materialize, and it should be considered a true liability. 2. An analyst determines that the deferred tax liability is unlikely to be realized for other reasons; the liability should then be reclassified as stockholders' equity. What is EVA? How is it superior to numerous other tools we have read and heard about? What is EVA? EVA is an acronym for Economic Value Added. It is defined as net operating profit less an appropriate charge for the opportunity cost of all capital invested in the enterprise. Let us proceed to take apart the definition a word at a time and understand the significance in its entirety. EVA = Net operating profit after tax - Capital charge Capital Charge = WACC * Net funds employed Net Funds Employed = Net fixed Assets + Net working capital Any organization (leaving aside non-profit ones) wants to make a profit. Profit, put in simple terms, is income minus expense. However, the catch here is that there are various categories of expenses to be taken into account, so let us organize them. There are, of course, the standard expenses incurred during the normal course of operation of business, which includes the material cost and various overheads including the electricity charges, traveling and conveyance expenses, telephone expenses, factory operating or office running expenses etc to name a few. Let us call them the first level expenses.

Apart from these, there are secondary expenses, like amortization, depreciation expenses, and taxes on profit made. Net operating profit is the operating income (not including other income categories like sale of assets etc) minus all first level and secondary expenses. It must be noted here that the obligations of an organization does not end with accounting for its first level and secondary expenses. The enterprise has borrowed money from financial institutions (debt) and its shareholders (equity), and these constitute the sources of funds for the organization. It doesnt take any accounting knowledge to figure out that these are the actual owners of the firm, and they expect a certain rate of return based on the risk of their investment. Hence let us proceed to deduct this expectation, also known as capital charge, from the net operating profit, to get a clear indication of the actual wealth created by the organization. The capital charge can also be represented as the combined expected rate of return of debt and equity (also called Weighted Average Cost of Capital) on the net capital invested in the company. The net capital can once again be broken down into long term assets as well as the working capital requirements for the business. What does EVA Signify? The focus of organizations has undergone a shift from mere profit maximization to value maximization. There is a clear distinction between the two. Profit, as simple as it might sound, is a net effect of a number of accounting methods and conventions; it is not a clear indicator of an organizations performance. The number of accounting scandals in recent times is a standing testimony to this fact. Value maximization on the other hand, has an obvious wider coverage. Two important doctrines are taken care of It takes into consideration the expectation which the shareholders or the owners of the company have. The expectation of the shareholders is a function of the risk borne by them. The more the risk, the more the return is expected. If you invest your hard earned money in the share market, you obviously expect more return than that given by a fixed deposit, because you are taking a greater risk. It imbibes the time value of money in its working, which stated in simple terms, means that the value of money keeps decreasing over time; Rs. 100 in your pocket now has more value than Rs. 100 in your pocket ten years from now. This leads to a very interesting concept that borrowed money, unless optimally utilized, leads to wastage and value erosion. Shifting this to an organization scenario, money is borrowed through debt and equity channels, and is utilized in generating long term assets and working capital, which is essentially the capital invested in the enterprise for which capital charge has to be paid. Let us understand this with the help of an example. Company ABC made a sale of Rs. 100 L in November, with a net operating profit of Rs. 20 L. The money due, however, was not collected from the customers till after one year from the date of invoicing. The capital charge on receivables will lead to diminished actual earnings, though there is no indication of the same by merely looking at the profit figure. By combining the profit parameter which emerges out of the operations of the company after taking into account all the expenses in that period of time; with components from

the balance sheet(Balance sheet indicates the magnitude of resources deployed for running the business), EVA gives a complete picture of an organizations accomplishment. A positive EVA indicates a healthy enterprise, there is no ambiguity about it. Simple to understand and measure, it inspires enough confidence in shareholders to be used as a universal performance measurement tool. It leads to an accurate reflection of the intrinsic value of any firm in its share prices, and when linked to a reward/compensation system, can motivate the employees to maximize their contribution to value creation. By emphasizing on increasing productivity and sales, cutting down on expenses, controlling working capital and making judicious well planned capital investments, EVA covers the entire gamut of business activities and offers all employees a role to play. Splutters of independent improvement initiatives organized haphazardly in random areas of working will not result in any discernable value creation, EVA will help in prioritizing them and attacking the weakest link of the chain to make maximum contribution with minimum effort. It can be perceived as a kind of business compass that will help immeasurably in the decision making process, be it day to day or important strategic ones. We hold in our hands a tool of unfathomable potential, its constant measurement and positive growth can spur the organization on to great heights and result in value creation not merely for the shareholders, but for all stakeholders. It is now left to all of us to grasp its importance and incorporate it into our working, to create an effective and efficient work environment Benefits and limitations of using EVA With the EVA as a performance measure, it is quite easy to see if a particular company, division or project is creating or destroying shareholder value. Traditionally, different measures like profitability ratio, asset utilization ratios and operating ratios have been used to evaluate performance. EVA makes managers focus their efforts on shareholder value. The simplicity of EVA makes it applicable to almost every corporation. In addition, EVA is a powerful tool for creating strong,sustainable, and cost-efficient incentives for managers compensation. Advantages of EVA EVA is more than just performance measurement system and it is also marketed as a motivational, compensation-based management system that facilitates economic activity and accountability at all levels in the firm. Stern Stewart reports that companies that have adopted EVA have outperformed their competitors when compared on the basis of comparable market capitalization. Several advantages claimed for EVA are:

EVA eliminates economic distortions of GAAP to focus decisions on real economic results EVA provides for better assessment of decisions that affect balance sheet and income statement or tradeoffs between each through the use of the capital charge against NOPAT

EVA decouples bonus plans from budgetary targets EVA covers all aspects of the business cycle EVA aligns and speeds decision making, and enhances communication and teamwork

Academic researchers have argued for the following additional benefits:

Goal congruence of managerial and shareholder goals achieved by tying compensation of managers and other employees to EVA measures (Dierks & Patel, 1997) Better goal congruence than ROI (Brewer, Chandra, & Hock, 1999) Annual performance measured tied to executive compensation Provision of correct incentives for capital allocations (Booth, 1997) Long-term performance that is not compromised in favor of short-term results (Booth, 1997) Provision of significant information value beyond traditional accounting measures of EPS, ROA and ROE (Chen & Dodd, 1997)

Limitations of EVA EVA also has its critics. The biggest limitation is that the only major publicly-available sample evidence on the evidence of EVA adoption on firm performance is an in-house study conducted by Stern Stewart and except that there are only a number of single-firm or industry field studies. Brewer, Chandra & Hock (1999) cite the following limitations to EVA:

EVA does not control for size differences across plants or divisions EVA is based on financial accounting methods that can be manipulated by managers EVA may focus on immediate results which diminishes innovation EVA provides information that is obvious but offers no solutions in much the same way as historical financial statement do

Also, Chandra (2001) identifies the following two limitations of EVA:

Given the emphasis of EVA on improving business-unit performance, it does not encourage collaborative relationship between business unit managers EVA although a better measure than EPS, PAT and RONW is still not a perfect measure

Brewer et al (1999) recommend using other performance measures along with EVA and suggest the balanced scorecard system. Other researchers have noted that EVA does not correlate as strongly with stock returns as its proponents claim. Chen & Dodd (1997) found that, while EVA provides significant information value, other accounting profit measures also provide significant information and should not be discarded in favor of EVA alone. Biddle, Brown & Wallace (1997) found only marginal information content beyond earnings and suggest a greater association of earnings with returns and firm values than EVA, residual income, or cash flow from operations.

Finally, a key criticism of EVA is that it is simply a retreaded model of residual income and that the large number of "equity adjustments" incorporated in the Stern Stewart system may not be necessary (Barfield, 1998; Chen & Dodd, 1997; O'Hanlon & Peasnell, 1998; Young, 1997). The similarity between EVA and residual income is supported by Chen and Dodd (1997) who note that most of the EVA and residual income variables are highly correlated and are almost identical in terms of association to stock return. Calculating EVA The definition of EVA outlines three basic inputs we need for its computation the return on capital earned on investments, the cost of capital for those investments and the capital invested in them. In measuring each of these, we will make many of the same adjustments we discussed in the context of discounted cash flow valuation. How much capital is invested in existing assets? One obvious answer is to use the market value of the firm, but market value includes capital invested not just in assets in place but in expected future growth1[1]. Since we want to evaluate the quality of assets in place, we need a measure of the market value of just these assets. Given the difficulty of estimating market value of assets in place, it is not surprising that we turn to the book value of capital as a proxy for the market value of capital invested in assets in place. The book value, however, is a number that reflects not just the accounting choices made in the current period, but also accounting decisions made over time on how to depreciate assets, value inventory and deal with acquisitions. At the minimum, the three adjustments we made to capital invested in the discounted cashflow valuation converting operating leases into debt, capitalizing R&D expenses and eliminating the effect of one-time or cosmetic charges have to be made when computing EVA as well. The older the firm, the more extensive the adjustments that have to be made to book value of capital to get to a reasonable estimate of the market value of capital invested in assets in place. Since this requires that we know and take into account every accounting decision over time, there are cases where the book value of capital is too flawed to be fixable. Here, it is best to estimate the capital invested from the ground up, starting with the assets owned by the firm, estimating the market value of these assets and cumulating this market value. To evaluate the return on this invested capital, we need an estimate of the aftertax operating income earned by a firm on these investments. Again, the accounting measure of operating income has to be adjusted for operating leases, R&D expenses and one-time charges to compute the return on capital. The third and final component needed to estimate the economic value added is the cost of capital. In keeping with our arguments both in the investment analysis and the discounted cash flow valuation sections, the cost of capital should be estimated based upon the market values of debt and equity in the firm, rather than book values. There is no contradiction between using book value for purposes of estimating capital invested and using market value for estimating cost of capital, since a firm has to earn more than its market value cost of capital to generate value. From a practical standpoint, using the book value cost of capital will tend to understate cost of capital for most firms and will understate it more for more highly levered firms than for lightly levered firms. Understating the cost of capital will lead to overstating the economic value added.

EVA vs. rate of return _ _ 1. Steering failure in ROI _ Increase in ROI is not necessarily good for shareholders i.e. maximizingROI can not be set as a target. (Increase in ROI would be unambiguouslygood only in the companies where capital can be neither increased nordecreased -> however we leave in a world where both operations areeasily executed in almost all companies) _ 2. EVA is more practical and understandable than ROI _ As an absolute and income statement -based measure EVA is quite easilyexplained to non-financial employees and furthermore the impacts ofdifferent day-to-day actions can be easily turned into EVA-figures sincean additional $100 cost decreases EVA with $100. (ROI is neither easy toexplain to employees nor can day-to-day actions easily be expressed interms of ROI) _ This latter benefit if often totally forgotten in academic discussion since itcan not, of course, be visible in desk studies or empirical studies whichtry to trace the correlation of EVA and share prices Reason 1: Steering failure in ROI _ Suppose of a SBU earning currently a return (ROI, ROIC, ROCE) of 30% and suppose that this SBU faces an investmentopportunity producing a return of 20% _ What happens to the ROI of the SBU if the investment is executed? Before investment: Capital 100, Operating profit 30, Capital cost 10% ROI = 30/100 = 30% , EVA = 30 - (10% x 100) = 20 Investments capital requirement 20, return 20%/year: Thus increase in yearly OPERATINGprofit is 20% x 20 = 4 After investment: Capital 120, Operating profit 34, Capital cost 10% ROI = 34/120 = 28% , EVA = 34 - (10% x 120) = 22 _ In this case decreasing ROI is good for the shareholders, thusROI should not be maximised and therefore it is problematiccontrolling tool. _ Usually large corporations have at least some very profitableunits and particularly these units are steered wrongly withROI Reason 2: EVA is more practical andunderstandable than rate of return (ROI...) (1/4) _ Usually the rate of return is not used and totally understood atthe lower levels of organizations in the companies using ROIas the prime performance measure. I.e. operating people likesales people, production engineers and supervisors etc. do notuse ROI while making day-to-day operating actions (they useoperating profit and perhaps also some turnover times instead) _ This kind of behaviour is obvious since cost reductions, revenueincreases, capital increases and reductions etc. are too difficult to convertinto change of ROI with day-today activities Furthermore those persentages would not be so informative or illustrative tooperating people than absolute dollar changes in operating profit _ This is even more understandable when we keep in mind that ROI is notan unambigious measure (slide 2: steering failure) Thus in ROI-steered companies the capital base is left to verylittle attention in operating activities and operating profit isemphasized _ Therefore the meaning of capital efficiency is often forgottenand some operating people do not even realize that tyingmoney in inventories or sales receivables is costly

_ I have heard comments that inventories are not very costly because short interest rates are only 3% per annum... _ EVA, in contrast to ROI, is as an absolute measure easy tointegrate into operating activities since all cost reductions andrevenue increases are already in terms of EVA (reduction incosts in one period = increase in EVA in the same period). Inthe similar fashion capital increases /reductions are also fairlyeasy to turn into change of EVA _ Furthermore EVA is (in contrast to ROI) an unambiguous measure i.e. increasing EVA increases always the position ofshareholders It is also very common that in ROI-steered companies manyemployees do not really know what profitability is _ Often many educated employees know something about the flaws of ROIand therefore they have some vague conception that real profitabilitymight also improve although ROI decreases Since the company does not have any better profitability measures it isadmittedly very difficult to get the whole picture about profitability _ ROI is also too complex consept to explain to all employees (not manycompanies have succeeded (or even tried) to explain to factory employeeswhat is ROI and what is real profitability and how they can influencethem) I have also met some financial accountants and account managers that do nothave comprehended completely what profitability is and what pitfalls ROIinclude so it is not wonder that these things are difficult to explain to otheremployees " Therefore ROI-steered companies and their employees do not always know how to operate to improve the real profitabilityi.e. the position of shareholders Profitability is often viewed as a difficult construct belongingto financial professional although it is in general outline aneasy consept understandable to all employees - the question isultimately whether a company can cover all its costs or not andhow much is the excess or deficit _ EVA clarifies the profitability into one unambigious andabsolute figure. Thereafter improving profitability is simplyincreasing EVA _ After implementing EVA it is fairly easy to explain to all employer groupswhat is profitability and where should the company aim at financially _ The reason for difficulties for operating people to understandprofitability have not been in the consept itself but with theperformance measures (like ROI) used so far Stock Splits A stock split occurs when a Board of Directors authorizes a change in the par or stated value of its stock. This reduction in par value is made to lower the market price of the stock to make the stock more attractive to potential investors. When a company's stock splits, the change in the par value is offset by a corresponding change in the number of shares so the total par value remains the same. The total stockholders' equity is unaffected by the stock split and no entries are recorded. For example, if Grandma's Girls declared a 3-for-1 stock split instead of a 10% stock dividend, the company would issue three shares in place of every one share currently held. After the split occurs, the par value or stated value is divided by 3 (because it is a 3-for-1 stock split) to determine the new par or stated value, and the number of outstanding shares is multiplied by 3. After the stock split, the new par value is $1 ($3 3) and the number of outstanding shares is 1,500,000 (500,000 3). The total par value of the common stock remains at

$1,500,000 (1,500,000 shares $1 par value). The following chart illustrates the effects of stock dividends and stock splits on stockholders' equity. Procedure for buy back of shares through Stock exchange from existing shareholders of the Company with the approval of shareholders via Postal Ballot 1. Check the Articles of Association of the Company, it must contain a provision authorising the company to buy-back their own shares or other specified securities. If the Articles do not contain a provision authorising buy-back, alter the articles of association by passing a special resolution in the general meeting. [Procedure for alteration in the Articles of Association] Convene and hold a Board Meeting after giving notice to all the directors [Section 286] to discuss besides others the following matters. To pass a [resolution] for buy-back of shares upto 25% of the total paid up capital and free reserve of the Company and also decide the price at which the company offers to the shareholders. (Section 77A) To appoint a Compliance officer for ensuring compliance of the provisions of the Act, the Regulations, listing Agreement and any other applicable laws relating to Buy-back of securities and to redress the grievances of the investors. To Appoint Merchant Banker who will take care of the whole proceeding. To decide the location about the investor service centre, it is desirable that such centres are opened in all such cities where the security holders holding 10% or more of the voting rights reside. To approve the notice of the resolution to be sent to the shareholders. To fix the responsibility of the entire postal ballot process to the Company Secretary and any functional director of the Company. To approve the postal ballot form along with the calendar of event.



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To appoint a scrutinizer, not being an employee, who is in the opinion of the Board of directors, can conduct the postal ballot voting process in a fair and transparent manner. Inform the Stock Exchange with which shares of the company are listed about the date of this meeting prior to the board meeting. [Clause 19 of the Standard Listing Agreement] Inform the said Stock Exchange within 15 minutes of the board Meeting, of the outcome of the meeting by letter or fax. File Board resolution along with the Calendar of event in [E-form no 61] with

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the Registrar of Companies within one week of the Board resolution. The resolution should be approved by majority i.e the votes cast in favour is three times or more than the votes cast against. File a certified true copy of the [special resolution] in [E-form no 23] with the concerned Registrar of Companies with in 7 days of the date of passing of the resolution and also file a copy of the same to the SEBI and Stock Exchange(s), where the securities of the company are listed. Make the payment of requisite fees, fees can be paid through Credit Card / by cash / by cheque in favour of MCA Collection Account ICICI Bank at the prescribed rates. (Fee Calculator) Forward to the Stock Exchange promptly three copies of the notice of postal ballot. [Clauses 31(c), (d) and 33 of the Standard Listing Agreement] After it has been authorised to buy-back, make a Public announcement at least 7 days before the commencement of buy-back at least one English, Hindi and Regional language Newspaper. Such public announcement shall contain the disclosures regarding detail of the Stock-Brokers and Stock Exchange(s) through which the buy-back of securities will be made. A copy of the Public announcement shall be filed with SEBI within 2 days of such announcement along with fees specified in Schedule V to the Regulation. A declaration of solvency in Form no 4A shall be filed with SEBI along with the draft letter of offer. It is also to be filed with Registrar of Companies simultaneously. Give information to the stock exchanges on daily basis regarding the securities purchased for buy-back and such information shall be published in a national daily. The company shall buy-back its securities only through the order matching mechanism, except all or none order matching system. The securities purchased by the company may not be necessary to be purchased at a uniform price. The company shall pay the consideration to the stock brokers on every settlement date. The verification should be completed with in 15 days from the date of closure. Extinguish and destroy the security certificate so bought back in the presence of Registrar to the issue\ merchant banker and the Statutory Auditors of the Company within 7 days from the date of verification of securities. Furnish a certificate to SEBI and the Stock Exchange(s) with in 7 days of extinguishments and destruction of the certificates. Such certificate shall be duly verified by the Registrar to the issue/ Merchant Banker and Statutory Auditors of the Company and two whole-time directors of the Company including the Managing Director. Issue a Public advertisement in the National daily with in 2 days of completion of buy-back. Prepare a Register of Securities Bought Back in Form no 4B. File a return in Form no 4C with the concerned Registrar of Companies and SEBI within 30 days of completion of Buy-back.

NOTE : The term 'buyback' has two meanings: First, when a business or person sells something, especially shares, and then buys them again according to a fixed agreement; the buying back by a company of its shares from an investor, who put venture capital up for the formation of the company. Secondly, the buying by a corporation of its own stock in the open market in order to reduce the number of outstanding shares; the buying by a corporation of its own stock in the open market in order to reduce the number of outstanding shares. The phrase 'buyback of shares' means the buying back of its shares or other securities by a company from the holders thereof. It is also referred to as share/stock buyback. A company limited by shares or company limited by guarantee and having a share capital buys or purchases from its shareholders the shares issued by it, at a certain price and thereby returns the share capital to those shareholders. The share capital bought back has the effect of reduction of share capital to the extent of the face value of the shares bought back and there is cash outflow from the company to the extent of the price of the shares paid to the shareholders. A buyback of shares results into the shareholders, whose shares are bought, ceasing to be the members of the company. Their names are omitted from the Register of Members. A buyback is different from redemption of share capital, e.g., redemption of redeemable preference shares. A buyback of equity shares may be driven by any one or more of the following factors: (1) To increase the underlying value of the share; (2) To enhance Earnings Per Share (EPS); (3) To reduce the excess share capital; (4) To rationalise the capital base by writing off the capital which is lost or unrepresented by the available assets; (5) To pay off surplus cash not required in the business; (6) To increase the shareholding of the promoters or those in the management control of the company; (7) To support share price during period of temporary weakness; (8) To prevent takeover bid; (9) As part of total financial restructuring; (10) As part of compromise or arrangement (including amalgamation). A company may be benefited in any one or more of the following ways from a buyback: (1) Flexibility to companies to reorganise their capital structure; (2) Improving return on capital, net profitability and Earning Per Share (EPS); (3) Rendering of better service to the remaining shareholders by way of sustained dividend and appreciation of share value in the long run; (4) Reducing the risk of possible raids owing to lesser volume of shares in circulation;

(5) Maintenance of the management control stable and continued business policies; (6) A viable preposition to investors to sell back the shares to the company instead of going through the secondary market mechanism; (7) Attracting equity investments in small businesses. Small businesses, which are mainly family concerns, are reluctant to raise capital from outsiders for fear of losing of control of business to outsiders. Outsiders on their part are reluctant to contribute capital to enterprises whose shares are not easily marketable and where there is risk of being locked-in; (8) Facilitating family rearrangements, enabling disgruntled members to realise their investments without the remaining family members being required personally to fund the purchase back of their shares; (9) Facilitating buying out discontented shareholders or employee share holdings when the employment ceases; (10) Eliminating fractional share holdings and odd lots. The following matters have a bearing on the decision to buyback securities: (1) Non-transferability of shares during lock-in period under SEBI Guidelines. (2) Non-transferability of shares due to the condition under an agreement with (a) a financial or development institution or bank lending money or providing financial assistance to the company; or (b) a venture capital company; or (c) any other party which has lent money to the company. (3) Non-transferability of shares due to the condition under a non-disposal undertaking given to a financial or development institution lending money or providing financial assistance to the company. (4) Non-transferability of shares due to the prohibition under a shareholders or joint venture agreement or an instrument setting forth a family arrangement. (5) Purchase of any shares by a company or sale of shares by a shareholder which (a) would be in contravention of any law, rules, regulations or conditions of approval given by any authority (e.g. FIPB, RBI, DCA, etc); (b) would require any permission or approval of financial institution, bank or other authorities; (c) is prohibited by an order of any court. (6) Probability of conditions under listing requirement or continued listing, such as minimum public shareholding, under rule 19(2)(b) of the Securities Contracts (Regulation) Rules, 1956, minimum number of public shareholders under clause 45 of the Listing Agreement. (7) Probability of the buying company ceasing to be a subsidiary company (or 100% subsidiary) if as a result of buyback of equity shares held by the holding company in the subsidiary which proposes to buy back the shares from the holding company. (8) If as result of the buyback the free reserves will diminish, its effect on

(a) the limit for acceptance of deposits under the Companies (Acceptance of Deposits) Rules under section 58A; (b) the limit under section 372A for inter-corporate investments, loans, guarantees and securities. (9) Probability of violation due to crossing the limit on shareholding by a director under rule 86 or 105 of the Income-tax Rules, 1962. (10) Effect of buyback on (a) the market price of the company's share due to reduction of floating stock in the market; (b) the market capitalisation; (c) borrowing capacity of the company; (d) debt-equity ratio; (e) other financial ratios which would upset the financial parameters which are usually applied to measure financial structure, liquidity, profitability, return on capital, etc; (11) Interest rate on borrowing from financial institutions or banks for working capital.

Some of these major differences between US GAAP and Indian GAAP which give rise to differences in profit are highlighted hereunder: 1. Underlying assumptions: Under Indian GAAP, Financial statements are prepared in accordance with the principle of conservatism which basically means Anticipate no profits and provide for all possible losses. Under US GAAP conservatism is not considered, if it leads to deliberate and consistent understatements. Prudence vs. rules : The Institute of Chartered Accountants of India (ICAI) has been structuring Accounting Standards based on the International Accounting Standards ( IAS) , which employ concepts and `prudence' as the principle in contrast to the US GAAP, which are "rule oriented", detailed and complex. It is quite easy for the US accountants to handle issues that fall within the rules, while the International Accounting Standards provide a general framework of accounting standards, which emphasise "substance over form" for accounting. These rules are less descriptive and their application is based on prudence. US GAAP has thus issued several Industry specific GAAP , like SFAS 51 ( Cable TV), SFAS 50 (Record and Music Industry) , SFAS 53 ( Motion Picture Industry) etc.



Format/ Presentation of financial statements: Under Indian GAAP, financial statements are prepared in accordance with the presentation requirements of Schedule VI to the Companies Act, 1956. On the other hand , financial statements prepared as per US GAAP are not required to be prepared under any specific format as long as they comply with the disclosure requirements of US GAAP. Financial statements to be filed with SEC include Consolidation of subsidiary companies: Under Indian GAAP (AS 21), Consolidation of Accounts of subsidiary companies is not mandatory. AS 21 is mandatory if an enterprise presents consolidated financial statements. In other words, the accounting standard does not mandate an enterprise to present consolidated financial statements but, if the enterprise presents consolidated financial statements for complying with the requirements of any statute or otherwise, it should prepare and present consolidated financial statements in accordance with AS 21.Thus, the financial income of any company taken in isolation neither reveals the quantum of business between the group companies nor does it reveal the true picture of the Group . Savvy promoters hive off their loss making divisions into separate subsidiaries, so that financial statement of their Flagship Company looks attractive .Under US GAAP (SFAS 94),Consolidation of results of Subsidiary Companies is mandatory , hence eliminating material, inter company transaction and giving a true picture of the operations and Profitability of the various majority owned Business of the Group. Cash flow statement: Under Indian GAAP (AS 3) , inclusion of Cash Flow statement in financial statements is mandatory only for companies whose share are listed on recognized stock exchanges and Certain enterprises whose turnover for the accounting period exceeds Rs. 50 crore. Thus , unlisted companies escape the burden of providing cash flow statements as part of their financial statements. On the other hand, US GAAP (SFAS 95) mandates furnishing of cash flow statements for 3 years current year and 2 immediate preceding years irrespective of whether the company is listed or not . Investments: Under Indian GAAP (AS 13), Investments are classified as Current and Long term. These are to be further classified Government or Trust securities ,Shares, debentures or bonds Investment properties Others-specifying nature. Investments classified as current investments are to be carried in the financial statements at the lower of cost and fair value determined either on an individual investment basis or by category of investment, but not on an overall (or global) basis. Investments classified as long term investments are carried in the financial statements at cost. However, provision for diminution is to be made to recognise a decline, other than temporary, in the value of the investments, such reduction being determined and made for each investment individually. Under US GAAP ( SFAS 115) , Investments are required to be segregated in 3 categories i.e. held to Maturity Security ( Primarily Debt Security) , Trading Security and Available for




sales Security and should be further segregated as Current or Non current on Individual basis. Debt securities that the enterprise has the positive intent and ability to hold to maturity are classified as held-tomaturity securities and reported at amortized cost. Debt and equity securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities and reported at fair value, with unrealised gains and losses included in earnings. All Other securities are classified as available-for-sale securities and reported at fair value, with unrealised gains and losses excluded from earnings and reported in a separate component of shareholders' equity 7. Depreciation: Under the Indian GAAP, depreciation is provided based on rates prescribed by the Companies Act, 1956. Higher depreciation provision based on estimated useful life of the assets is permitted, but must be disclosed in Notes to Accounts.( Guidance note no 49) . Depreciation cannot be provided at a rate lower than prescribed in any circumstance. Similarly , there is no compulsion to provide depreciation at a higher rate, even if the actual wear and tear of the equipments is higher than the rates provided in Companies Act. Thus , an Indian Company can get away with providing with lesser depreciation , if the same is in compliance to Companies Act 1956. Contrary to this, under the US GAAP , depreciation has to be provided over the estimated useful life of the asset, thus making the Accounting more realistic and providing sufficient funds for replacement when the asset becomes obsolete and fully worn out. Foreign currency transactions: Under Indian GAAP(AS11) Forex transactions ( Monetary items ) are recorded at the rate prevalent on the transaction date .Year end foreign currency assets and liabilities ( Non Monetary Items) are re-stated at the closing exchange rates. Exchange rate differences arising on payments or realizations and restatements at closing exchange rates are treated as Profit /loss in the income statement. Exchange fluctuations on liabilities incurred for fixed assets can be capitalized. Under US GAAP (SFAS 52), Gains and losses on foreign currency transactions are generally included in determining net income for the period in which exchange rates change unless the transaction hedges a foreign currency commitment or a net investment in a foreign entity . Capitalization of exchange fluctuation arising from foreign liabilities incurred for acquiring fixed assets does not exist. Translation adjustments are not included in determining net income for the period but are disclosed and accumulated in a separate component of consolidated equity until sale or until complete or substantially complete liquidation of the net investment in the foreign entity takes place . US GAAP also permits use of Average monthly Exchange rate for Translation of Revenue, expenses and Cash flow items, whereas under Indian GAAP, the closing exchange rate for the Transaction date is to be taken for translation purposes. Expenditure during Construction Period: As per the Indian GAAP (Guidance note on Treatment of expenditure during construction



period' ) , all incidental expenditure on Construction of Assets during Project stage are accumulated and allocated to the cost of asset on completion of the project. Contrary to this, under the US GAAP (SFAS 7) , such expenditure are divided into two heads direct and indirect. While, Direct expenditure is accumulated and allocated to the cost of asset, indirect expenditure are charged to revenue. 10. Research and Development expenditure: Indian GAAP ( AS 8) requires research and development expenditure to be charged to profit and loss account, except equipment and machinery which are capitalized and depreciated. Under US GAAP ( SFAS 2) , all R&D costs are expenses except intangible assets purchased from others and Tangible assets that have alternative future uses which are capitalised and depreciated or amortised as R&D Expense. Under US GAAP, R&D expenditure incurred on software development are expensed until technical feasibility is established ( SOP 81.1) . R&D Cost and software development cost incurred under contractual arrangement are treated as cost of revenue. 11. Revaluation reserve : Under Indian GAAP, if an enterprise needs to revalue its asset due to increase in cost of replacement and provide higher charge to provide for such increased cost of replacement, then the Asset can be revalued upward and the unrealised gain on such revaluation can be credited to Revaluation Reserve ( Guidance note no 57). The incremental depreciation arising out of higher book value may be adjusted against the Revaluation Reserve by transfer to P&L Account. However for window dressing some promoters misutilise this facility to hoodwink the shareholders on many occasions. US GAAP does not allow revaluing upward property, plant and equipment or investment. 12. Long term Debts: Under US GAAP , the current portion of long term debt is classified as current liability, whereas under the Indian GAAP, there is no such requirement and hence the interest accrued on such long term debt in not taken as current liability. 13. Extraordinary items, prior period items and changes in accounting policies: Under Indian GAAP( AS 5) , extraordinary items, prior period items and changes in accounting policies are disclosed without netting off for tax effects . Under US GAAP (SFAS 16) adjustments for tax effects are required to be made while reporting the Prior period Items. 14. Goodwill: Under the Indian GAAP goodwill is capitalized and charged to earnings over 5 to 10 years period. Under US GAAP ( SFAS 142) , Goodwill and intangible assets that have indefinite useful lives are not amortized ,but they are tested at least annually for impairment using a two-step process that begins with an estimation of the fair value of a reporting unit. The first step is a screen for potential impairment, and the second step measures the amount of impairment, if any. However, if certain criteria are met, the requirement to test

goodwill for impairment annually can be satisfied without a remeasurement of the fair value of a reporting unit. 15. Capital issue expenses: Under the US GAAP, capital issue expenses are required to be written off when incurred against proceeds of capitals, whereas under Indian GAAP , capital issue expense can be amortized or written off against reserves. Proposed dividend: Under Indian GAAP , dividends declared are accounted for in the year to which they relate. For example, if dividend for the FY 19992000 is declared in Sep 2000 , then the corresponding charge is made in 20002001 as below the line item . Contrary to this , under US GAAP dividends are reduced from the reserves in the year they are declared by the Board. Hence in this case under US GAAP , it will be charged Profit and loss account of 20002001 above the line. Investments in Associated companies: Under the Indian GAAP( AS 23) , investment in associate companies is initially recorded at Cost using the Equity method whereby the investment is initially recorded at cost, identifying any goodwill/capital reserve arising at the time of acquisition. The carrying amount of the investment is adjusted thereafter for the post acquisition change in the investors share of net assets of the investee. The consolidated statement of profit and loss reflects the investors share of the results of operations of the investee.are carried at cost . Under US GAAP ( SFAS 115) Investments in Associates are accounted under equity method in Group accounts but would be held at cost in the Investors own account.




Preoperative expenses: Under Indian GAAP, (Guidance Note 34 Treatment of Expenditure during Construction Period), direct Revenue expenditure during construction period like Preliminary Expenses, Project related expenditure are allowed to be Capitalised. Further , Indirect revenue expenditure incidental and related to Construction are also permitted to be capitalised. Other Indirect revenue expenditure not related to construction, but since they are incurred during Construction period are treated as deferred revenue expenditure and classified as Miscellaneous Expenditure in Balance Sheet and written off over a period of 3 to 5 years. Under US GAAP ( SFAS 7) , the concept of preoperative expenses itself doesnt exist. SOP 98.5 also madates that all Start up Costs should be expensed. The enterprise has to prepare its balance sheet and Profit and Loss Account as if it were a normal running organization. Expenses have to be charged to revenue and Assets are Capitalised as a normal organization. The additional disclosure include reporting of cash flow, cumulative revenues and Expenses since inception. Upon commencement of normal operations, notes to Statement should disclose that the Company was but is no longer is a Development stage enterprise. Thus , due to above accounting anomaly, Accounts prepared under Indian GAAP , contain higher charges to depreciation which are to be adjusted suitably under US GAAP adjustments for indirect preoperative expenses and foreign currencies. 19. Employee benefits: Under Indian GAAP, provision for leave encashment is accounted based n actuarial valuation. Compensation to employees who opt for

voluntary retirement scheme can be amortized over 60 months. Under US GAAP, provision for leave encashment is accounted on actual basis. Compensation towards voluntary retirement scheme is to be charged in the year in which the employees accept the offer. 20. Loss on extinguishment of debt: Under Indian GAAP, debt extinguishment premiums are adjusted against Securities Premium Account. Under US GAAP, premiums for early extinguishment of debt are expensed as incurred.