IFRS: Convergence gives Flexibility to adjust

On July 17, 2010, a section of the press has quoted Salman Khurshid, the Minister for Corporate Affairs’ saying “Convergence gives you the flexibility to stop where you want to stop, adjust where you want to adjust and make an exception where you want to make an exception.” He further said, “...There will be areas where ‘fair value' will apply, there will be areas where it need not apply,” Mr Khurshid was answering questions in the context that large Indian companies will transit to a new set of accounting standards to be issued by the Ministry of Corporate Affairs from April 1, 2011. The new set of accounting standards will be fully convergent with IFRS.

 

The decision to converge and not to adopt IFRS gives the flexibility to carve out and carve in accounting principles and methods in IFRS. The important question is to what extent we should use this flexibility. If, we make significant changes in IFRS using the flexibility, the new accounting standards will not be fully convergent with IFRS and the purpose of convergence will be lost. Our accounting practices will fall short of globally accepted accounting practices. This will hurt Indian investors and companies. Inflow of foreign capital will be affected adversely. Indian companies, which are listed in stock exchanges in USA, Europe and other countries, which use accounting standards fully convergent with IFRS, will have to prepare two sets of financial statements. The government understands this. Therefore, it may be incorrect to interpret Mr. Khurshid’s statement as a hint to change in government policy to issue accounting standards fully convergent with IFRS.

A section of accountants have reservations about fair value accounting. They believe that use of fair value accounting will lead to disaster and major accounting frauds in future. According to them accounting base on historical cost is more robust than fair value accounting because cost can be measured objectively, while fair value is an opinion in the sense that it depends much on the premises and assumptions made by the valuer. Therefore, the fair value can be engineered. Proponents of historical cost method of accounting focus more on reliability and prefer to compromise relevance in a situation of conflict between relevance and reliability. The users of financial statements focus on relevance.

They prefer to reduce the threshold of reliability in a situation of conflict between relevance and reliability. This is so because analysts invariably restructure financial statements to suit their needs. It is easier to restructure financial statements which provide information that is relevant for decision making. IFRS uses fair value to measure some assets and liabilities because use of cost to measure those assets and liabilities reduces the information value of financial statements. For example, there is no better alternative than measuring obligations arising from a defined benefit pension scheme and related plan assets at fair value. Similarly, fair value is the most appropriate basis for the measurement of biological assets. Use of cost method in measuring those assets results in understatement of net worth in the balance sheet, because no part of the total cost of managing biological assets is capitalised.

Again, there is no strong argument against the fair value measurement of financial instruments and investment property. It will be a retrograde step to carve out fair value measurement of assets and liabilities for which fair value is the most appropriate basis of measurement.

The concerns of those who do not favour fair value accounting need to be addressed as we implement accounting standards fully conver-gent with IFRS. The only way to address those concerns is to develop a well regulated valuation profession. Auditors always rely on expert opinion whenever the issue is beyond their comprehension. For example, auditors rely on legal opinion on legal issues.

Opinion on a complex legal issue by different legal experts may dif-fer. But no one argues against auditor’s reliance on legal opinion because legal profession is well regulated and it is well accepted that com-plex legal issues are beyond the comprehension of an accounting professional.

It is expected that the government will take all initiatives to develop a well regulated valuation profession at an accelerated pace. This will provide comfort to both auditors and users of financial statements.

E-mail: asish.bhattacharyya@gmail.com