Indian Economic Turbulence – A Comparative View

Also published on http://www.caclubindia.com/articles/indian-economic-turbulence-a-comparative-view-13950.asp

 

Finance Minister Pranab Mukherjee on Wednesday, 23^rd May 2012, assured Parliament that India's growth story remained intact despite Euro zone crisis and Greece turmoil. Mr. Mukherjee attributed the downward trend in the share markets to the global economic crisis.

However we need to introspect and appreciate the “Growth Story” of India in comparison with our neighbours. Let us take the recent hike in petrol prices and the foreign exchange rates as a point of comparison of economic governance of the Country.

Following is the table that benchmarks petrol prices after using respective country’s exchange rate and then comparing with INR for parity:

Country	$ per Ltr 2010	INR/ ltr  @ 45.9	$ per Ltr 2011	INR/ ltr @ 49.26	$ per Ltr 2012	INR/ ltr @55	% Deviation from India, 2012
USA	0.64	30.00	0.96	48.40	0.96	53.00	-32%
Pakistan	0.79	36.60	0.97	45.80	1.12	61.60	-21%
India	1.22	56.00	1.48	72.90	1.42	78.00	--

Source: www.kshitij.com/research/petrol.shtml. Nos updated for 2012.

We can see that over the period from 2010 till 2012, people of India have paid more for every ltr of petrol when compared to Pakistan and US. Isn’t there any issue on balance of payments!!

Again, when it comes to exchange rates, the depreciation of Indian rupee is much high than compared to Pakistan. The exchange rate of Feb 2012 was 90:1 which moved upto 91.5:1 in May 2012, hardly any fluctuation when compared to Indian market which moved from 50 to 56 in the same 90 day period.ie 12%.

When we say that India is a growing economy, does it mean that cost of living of the Country should also increase in an exponential manner!! It is said that we have a strong growth story, which is benchmarked with the GDP rates of India over the period. But can high GDP rates be seen in isolation?

It is been 8 years during which one may say that the sensex has risen from 6,000 to 16,000 but inflation rates have also been on upsurge since then. Is it a real growth? Companies are increasing the prices of goods and services constantly and raising their margins to boost EPS and PE multiples. Even prices of essential commodities such as dairy products, foodgrains etc have all doubled and tripled in many cases.    

Period	Inflation*	Sensex**	India GDP rate^	Pak GDP rate^
March 2012	8.649 %	15,948	-	-
March 2011	8.823 %	15,455	7.5	3.0
March 2010	14.865 %	20,510	10.094	3.759
March 2009	8.029 %	17,465	6.771	1.722
March 2008	7.874 %	9,647	6.186	3.685
March 2007	6.723 %	20,286	9.991	6.815
March 2006	4.571 %	13,786	9.53	5.818
March 2005	4.167 %	9,397	9.033	8.958
March 2004	3.491 %	6,602	7.591	7.483

* http://www.global-rates.com/economic-indicators/inflation/consumer-prices/cpi/india.aspx

**http://www.bseindia.com/histdata/hindices2.asp

^ http://www.tradingeconomics.com

Prices in India have been on rising scale since 2004, especially the realty price index is not seeing a sign of correction. The growth in GDP is not visible to common man who is exposed to such high rates of inflation. Per capital GDP of India was $3500 as compared to $ 46,800 of United States for 2010. The numbers have not improved as understood from the GDP growth rates. The cost of living in metros especially in Mumbai is inching towards that in United States but without matching income. The increase in salaries over last 3 years has been in single digit where as the real consumer prioce inflation has been in double digits.

 

Its time to introspect in our Governance Policies and come out with the right fix. It is quite possible that the more internationalization and exposure to international commodity markets has impacted us adversely and have contributed to inflation and volatility.

It is however surprising that the cattle in India that feeds on the grass grown in India has also been producing milk whose prices have also not been controlled. Probably these are side effects of inflation linked Governance and Growth.

Pakistan’s GDP rate is just half of India’s GDP and is not a rising trend, still they are in control of Foreign exchange rate and Petrol prices to name a two, then why not India!

Sanjay Chauhan

Compulsory Convertible Instruments under Revised Schedule VI

A. Introduction

Indian Entities have issued Foreign Currency Compulsory Convertible Bonds / Compulsory convertible debentures. How should the same be classified under revised Schedule VI?

B. Revised Schedule VI – Excerpt from Guidance Note

The Ministry of Corporate Affairs (MCA) has issued a revised form of Schedule VI on February 28, 2011. As per the notification 2/6/2008-C.L-V, dated 30-3-2011, the Schedule applies to all companies for the Financial Statements to be prepared for the financial year commencing on or after April 1, 2011. (para 3.1.)

Where compliance with the requirements of the Act including Accounting Standards as applicable to the companies require any change in treatment or disclosure including addition, amendment, substitution or deletion in the head/sub-head or any changes inter se, in the Financial Statements or statements forming part thereof, the same shall be made and the requirements of the Schedule VI shall stand modified accordingly.

As per ICAI Guidance Note on Terms Used in Financial Statements, ‘Capital’ refers “to the amount invested in an enterprise by its owners e.g. paid-up share capital in a corporate enterprise. It is also used to refer to the interest of owners in the assets of an enterprise.” (para 8.1.1.2.)

The said Guidance Note defines ‘Share Capital’ as the “aggregate amount of money paid or credited as paid on the shares and/or stocks of a corporate enterprise.” (para 8.1.1.3.)

 In respect of disclosure requirements for Share Capital, the Revised Schedule VI states that “different classes of preference share capital to be treated separately”. A question arises whether the preference shares should be presented as share capital only or does it mean that a company compulsorily needs to decide whether preference shares are liability or equity based on its economic substance using AS 31 Financial Instruments: Presentation principles and present the same accordingly. The Revised Schedule VI deals only with presentation and disclosure requirements. Accounting for various items is governed by the applicable Accounting Standards. However, since Accounting Standards AS 30 Financial Instruments : Recognition and Measurement, AS 31 and AS 32 Financial Instruments: Disclosures are yet to be notified and Section 85(1) of the Act refers to Preference Shares as a kind of share capital, Preference Shares will have to be classified as Share Capital. (para 8.1.1.4.)

Standards Notified by Ministry of Corporate Affairs

Institute of Chartered Accountants of India (ICAI) has issued 29 Indian Accounting standards before the Convergence to IFRS road map was laid. All these 29 accounting standards are notified by Ministry of Company Affairs (MCA).

As a part of alignment to International Standards, ICAI had issued by the applicable Accounting Standards, AS 30 Financial Instruments: Recognition and Measurement, AS 31 and AS 32 Financial Instruments: Disclosures. However these standards are not notified considering the convergence road map to IFRS.

The MCA has further notified 35 Indian IFRS standards (known as “Ind-AS’), without announcing the applicability date. In its press release dated February 25, 2011, the MCA has stated that Ind-AS will be applied in a phased manner, to ensure smooth transition for all stakeholders.

D. Accounting under Ind AS 32

Para 11

An equity instrument is any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities.

Para 16

When an issuer applies the definitions in paragraph 11 to determine whether a financial instrument is an equity instrument rather than a financial liability, the instrument is an equity instrument if, and only if, both conditions (a) and (b) below are met.

(a) The instrument includes no contractual obligation:

(i)  to deliver cash or another financial asset to another entity; or

(ii) to exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavourable to the issuer.

(b)If the instrument will or may be settled in the issuer’s own equity instruments, it is:

(i) a non-derivative that includes no contractual obligation for the issuer to deliver a variable number of its own equity instruments; or

(ii) a derivative that will be settled only by the issuer exchanging a fixed amount of cash or another financial asset for a fixed number of its own equity instruments. For this purpose, rights, options or warrants to acquire a fixed number of the entity’s own equity instruments for a fixed amount of any currency are equity instruments if the entity offers the rights, options or warrants pro rata to all of its existing owners of the same class of its own non-derivative equity instruments. Apart from the aforesaid, the equity conversion option embedded in a convertible bond denominated in foreign currency to acquire a fixed number of the entity’s own equity instruments is an equity instrument if the exercise price is fixed in any currency.

E. Understanding Drawn

Objective of Revised Schedule VI is to align the Statutory Format of Financial Statements with that of the Regulatory Framework laid by the Institute of Chartered Accountants of India (ICAI).

As part of the Guidance note issued by ICAI, we can visualize the intent being in line with the Convergence to IFRS framework.

It is understood from the exposure draft of the guidance note to Revised Schedule VI read with the guidance issued by ICAS in April 2011 for adoption of AS 30, 31 and 32, that the entity can classify a Redeemable Preference Shares as “Liability” if the entity follows the measurement and classification requirements of AS 30, 31, and 32 so far that they do not over rule the requirements of existing accounting standards.

However, the final version of guidance note came out with a caveat of notification and thus AS 30 principles would not apply while presenting balance sheet under Revised Schedule VI.

It is to be noted that on one side AS 30, 31 and 32 are not notified but Ind AS 32 and 39 are notified by the MCA on February 25, 2011.

Adopting the principles of Ind AS which are notified standards under MCA, would be in line with the intent of the final draft satisfying the criteria of being notified by MCA and thus reporting the substance.

F.  Disclsoure

Entities may reclassify them from liabilities and bring it with Shareholders' funds after Reserves & Surplus".

Alternatively, the same can be separately classified on the face sheet below Shareholders Funds and before Non current liabilities.

Since Revised Schedule VI is not a rigid format, an appropriate disclosure along with complete note justifying such substance of equity may well be considered.

Note: These are personal views and not of any firm or organisation.

Sanjay Chauhan   

International Financial Reporting Standard (IFRS): Principle based Standard:

IFRS are considered a "principles based" set of standards that establish broad rules for accounting.

Rules-based standards such as US GAAP have an accounting rule for almost every type transaction. There are various oversight bodies whose objective is to roll out accounting for every new transaction based on its materiality very now and then. It though minimizes confusion and the need to apply professional judgment in areas of accounting and reporting, these exhaustive rules and exceptions with various materiality limits, typically result in an increased level of complexity and lead to divergent accounting treatments for similar transactions. Another factor is that the Companies focus on mere technical compliance rather than on the objectives underlying the rules. The accountants restrict their application of mind only till finding a particular rule instead of conceptually addressing the unique transaction. Sometimes it may so happen that the accountant may not be aware of some rule that may have been written for a particular transaction and thus may account it in a regular manner in the absence of an overseeing principle.

Principle standards, on the other hand, define guidelines on a broad parameters or boundaries. It thus requires implementation team to exercise significant judgment and thought process to go to the underlying basis of conclusions. The structure of these standards giving a clear insight as to why the standard is introduced, what are its objectives, its scope of area, accounting guidelines, basis of conclusion with dissenting opinion of the board members and also the illustrative examples. Thus it provokes thoughts and establishes conceptual principles that can be applied universally and hence improving comparability. IFRS thus brings out the economic substance of the transaction.

No single set of rules is likely to eliminate the need for accounting professionals to make occasional judgment calls. A principles-based system, however, remedies several of the ills of other standards and minimizes opportunities for companies to meet a standard's technical requirements while ignoring its underlying objective. 

Some examples of Principles are as follows:

1.       Continuous involvement with the asset:

This is one of the principle test applied when an entity has to consider whether it can book the transaction as sold or not. This can be seen very commonly in factoring i.e. discounting bills receivable. If the discounting of bills or receivable is done with recourse, then the transaction does not allow the entity to derecognize receivable and book cash in balance sheet. Instead the said flow of funds from discounting is considered as a borrowing from the bank. This is because, if the debtor fails, the lender will come to the entity for recovery of the underlying receivable.

2.       Splitting  time value of money:

Any transaction that has a credit period different from that of similar transaction is considered to have an inbuilt finance arrangement / benefit to either party. Take for example if an entity has received a non interest bearing long term advance for delivery of goods or services over next two years, the opportunity interest of those funds is considered as financial benefit received by the entity. Thus the advance is present valued using the market interest rate of deposits for initial recognition and the difference is considered as deferred revenue on balance sheet. The advance is then accreted with interest expense through profit & loss account and deferred revenue on the balance sheet is unwound by crediting the revenue as and when goods are delivered or services rendered.  

Cloud in Spectrum

It is quite some time now since the first biggest so called “Scam” of the ruling UPA government was brought to light by the Comptroller and Auditor General (C&AG) of India. The estimate of loss to the Government ranged from Rs 4,000 crores to Rs 2,00,000 crores as read in the most reputed newspapers and as broadcasted by the high TRP news channels. Isn’t it strange to unearth such a huge discrepancy after so many years of spectrum allocation. Anyways, I assume that our learned professionals must have thought many times before declaring a war against the Common man’s interest of this Country. Yes, this is a war where on one side, there are Political Parties and on the other hand, the vast populace of this Country, which is seen to be a cash cow.

Everyone seems to forget one fact that Spectrum is a national resource, the so called scam of allocation that originated 5 years back in 2007 when the growth story of India had begun during 2005-06. If there was a real loss to the government, then how can government achieve such excellent growth rates after being fooled in waves distribution from 2005 till 2010. It is just a Mark to Market calculation in excel file. The actual loss if any should be worked out based on unjust enrichment to the parties.  

Another thing which is important is that the final losers with the revised policy allocation is no one but we the people. If the Government is successful in getting high fees for the airwaves from the Corporates, the same will be passed on to us as we are the final consumers.

I somehow fail to understand the Policy of the Government with respect to allocation of natural resources when the end consumption in the value chain is within India. For instance, Spectrum is utilized by Indian Consumers and hence the cost of procurement of such Spectrum by Corporate is thus a pass through to our pockets.

Why not we follow a Public Private Partnership (PPP) model wherein the Spectrum is given at a low price and as part of the contract, the tariff are also fixed by the Government so that the Corporate does not benefit or take any arbitrage opportunity.

Other perspective is that when we have the benefit of hindsight, we can find faults in all the past deeds. But the positive outcomes of thise deeds are unseen, such as the “One Rupee” per minute revolution in the Telecommunication of India, which was the then cheapest rate of calling in the world and still continues to be.

If the Government continues with its selfish and anti common man policies, I am sure that we the same people will be paying the highest tariff for telecommunication in the world in future..          

Revised Schedule VI

Principles:

1.       Revised Schedule VI is applicable from financial year commencing on or after 1st April 2011. Comparative amounts to be given for 2010-11 except for the first financial statements.

2.       Circular issued by the MCA clarifies that financial statements for purpose of IPO/FPO during the financial year 2011-12 maybe in the format of the pre revised schedule VI. However, for period beyond 31st March 2012, new format is applicable.

3.       The requirements of the Act and AS will prevail over Schedule VI. Terms to be interpreted as per applicable Accounting Standards e.g. Cash and Cash equivalents disclosure.

4.       Changes in numeric presentation rule - If turnover is less than Rs 100 crores then rounding off can be done to the nearest hundreds, thousands, lakhs or millions, or decimals thereof and if turnover is Rs 100 crores or more then rounding off can be done to the nearest, lakhs, millions or crores, or decimals thereof.

5.       Format of Cash Flow statement has not been prescribed. Only vertical format has been prescribed.

6.       Income statement classification continues to be based on nature of expenses as was there in old schedule VI. Under IFRS, the classification is mostly based on functions.

7.        The current / non-current classification in Balance sheet is broadly in line with that of IAS 1.

Classifications:

1.       Convertible Bonds / Liabilities continue to be classified as Borrowings unless Company follows Ind AS for accounting such compound instruments which splits the instrument as Debt and Equity.

2.       Trade Receivables: Outstanding period means a period exceeding six months from the “due date” in revised Schedule VI as against “bill date” as part of Old Schedule VI

3.       Deferred Tax liabilities/asset will always be classified as Non-current.

4.       Capital Advances is no longer part of CWIP, instead it will now form part of Long Term Loans and Advances i.e. Non Current.

5.       Retirement Benefits will have to be classified as current as well as non-current, unlike IFRS where it is always Non-current.

Regarding funded post-employment benefit obligations, amount due for payment to the fund within twelve months created for this purpose is treated as “current” liability. Regarding the unfunded postemployment benefit obligations, a company will have settlement obligation at the Balance Sheet date or within twelve months for employees such as those who have already resigned or are expected to resign (the Actuary factors this information for actuarial valuation) or are due for retirement within the next twelve months from the Balance Sheet date. Thus, the amount of obligation attributable to these employees is a “current” liability. The remaining amount attributable to other employees, who are likely to continue in the services for the next twelve months, is classified as “non-current” liability. The actuaries should be requested to provide the amount of current & non-current liability for unfunded post-employment benefit obligation based on the definition of Current and Non-Current Assets and Liabilities in the Revised Schedule VI.

6.       Acceptances will be part of Trade payables and to be classified as current / Non-current based on its maturities.

7.       Debit balance in Profit & loss account to be shown as part of Reserves and Surplus, even if the resultant figure of the entire schedule is in negative.

8.       Fixed deposits having original maturity of less than three months are cash equivalents and more than 3 months but less than 12 months are classified as other current assets.

9.       Share application money pending allotment is shown separately between Shareholders funds and Non Current Liabilities, thus treating it as Quasi Equity. Under IFRS it is either part of Equity or Liability.
10. Covenant breach does not necessarily call for current classification of long term borrowings.