New ICAI norms could expose India Inc closet

Written by Akash Joshi | Mumbai, Mar 30 | Updated: Mar 31 2008, 07:03am hrs
As authorities set out to clean India Incs balance sheet, skeletons are set to tumble out of the closet. A Saturday night announcement by the Institute of Chartered Accountants (ICAI), directing companies to follow new accounting norms that would require them to disclose and provide for their derivatives losses with immediate effect, could well be the cause.

While many aspects, especially the application of this announcement, remain unclear, the fact that auditors will have to look into this matter and make necessary qualifications in their reports, will scare corporates. Viren Mehta, director, Ernst & Young India, puts things in perspective, After the issuance of the AS30, there was no guidance provided for forward-thinking corporates wanting to adopt early the AS30. What the ICAIs announcement does is to allow corporates to adopt the AS30 as early as March 31, 2008. The announcement does not make early adoption mandatory. Corporates wishing to adopt the AS30 later will need to record unrealised losses from their financial instruments, using the principles of prudence articulated in the AS1. This is not a new principle and always existed.

The guidance states, The auditors should consider making appropriate disclosures in their reports if the aforesaid accounting treatment and disclosures are not made. These standards, as mentioned in the AS30, were slated to be implemented voluntarily after 2009 and compulsorily from 2011. What might catch corporates on the wrong foot is the fact that it has been advanced. For this, Mehta adds, Clarifications will need to be provided to corporates early adopting the AS30 as some of the principles detailed in other accounting standards that are notified under the Companies (Accounting Standards) Rules 2006 are differing from the principles detailed in the AS30 which has not yet been notified by those Rules.

If this happens, companies will find it difficult to hide their derivatives losses, says Mandar Gupte, chief financial officer with a leading multinational.

Exposure to exotic derivatives for Indian corporates is estimated to be in a range of $1-$5 billion. A study by Ernst & Young indicates that around 44% of Indian corporates have exposure to such exotic derivatives.

This also comes at a time when new directions from the CBDT under Section 14(a) rationalise the manner in which Indian corporates have been seeking exemptions on income earned from investments. India Incs earnings growth party that lasted for several quarters could well be pooped.

In the race to show strong earnings growth, Indian corporates have been resorting to using treasury operations to shore up numbers. For the past four quarters other income as a percentage of the profit before tax has been around 30-40% levels.

Already, companies like Hexaware and Amtex Auto have talked about losses caused due to exposure to exotic derivatives. Hexaware officials state the extent of losses to be around $20 -$25 billion, the potential losses for Amtex Auto could be around $18 million. While small and medium enterprises seem to have been indulging in these shenanigans, large corporates could also be implicated. L&T could also report a Rs 200 crore loss on account of an exposure to commodity derivatives.

Bigger corporates, especially in commodity related businesses, are known to take huge exposures in the derivatives market. The banking sector too will be impacted, say analysts. While banks have been the conduit for most of such deals, corporates have been blaming bankers for misleading them to take on exotic derivatives that do not have any upfront explicit costs as compared to a forward cover.

The positive movement of the rupee and the economy kept things in place and many corporates earned. Some even indulged in the notorious yen carry trade where monies borrowed at lower cost from a Japanese yen were deployed in the Indian stock market. With the yen appreciating, and the markets tanking, the Indian yen carry trade has dealt severe blows to savvy treasury heads, many of which will roll in the days to come.