The Hindu Business Line : Not standard fare

THE switch to international financial reporting standards is one of the most significant events in accounting history. Given the immense pressure the complex process places on companies, one hopes the matter will be dealt with smoothly and professionally by those responsible for laying this burden at their doorstep. However, in the case of one standard, IAS 39, which deals with accounting and measuring financial instruments, the International Accounting Standards Board (IASB) had to face much flak when the standard was announced.

The general feeling was that this was an updated version of its predecessor — IAS 32. However, reading the fine-print revealed certain minefields, especially with regard to `fair market value' valuation for liabilities and performance reporting, that companies refused to cross. Companies were up in arms against the standard-setters stating that they could not comply with a standard that rewrote existing accounting practice in toto. The end result was two different versions of the standard — a full version from the IASB and a European Commission-endorsed `carved-out' one.

This led to pressure from the EC on the IASB to make changes to the standard. Two parts of the standard were under scrutiny — hedge accounting and the fair value option. The IASB, however, would not budge, and Europe decided that the only way of pressing ahead was to remove the most controversial parts until the situation was resolved. There are two key differences between Euro IAS 39 and the IASB's full IAS 39.

In the Euro version, the fair-value option for financial liabilities is removed, and certain aspects of portfolio fair-value hedge accounting of interest rate risk have been relaxed. The IASB has decided that instead of tinkering with the standard, it would be better to rewrite it.

This has created a precarious situation. IAS 39 is probably the most complex and resource consuming standard for large companies to apply. It is also the standard that analysts, shareholders and other market watchers will struggle hardest to comprehend.

Now that there are two different versions of it doing the rounds, confusion could abound and comparing company accounts becomes increasingly troublesome. A working group has been set up by the board to explore hedge accounting issues and problems, but there is no guarantee that it will bring any short-term resolutions.

The impact of this Standard is already beginning to be felt. Scottish Power has warned investors that the controversial IAS 39 could have a big impact on profits when the company reports interim results next month, as the standard is likely to cause movements in the fair value of its bonds and energy contracts.

Statistics reveal that a total of 95 countries are now using International Accounting Standards. A convergence effort is currently on with the US, China, Japan and Korea. The IASB is confident that soon China, India and South America would have trustees on its Board.

The Institute of Chartered Accountants of India (ICAI) recently brought out an Exposure Draft (ED) on financial instruments. This is largely based on IAS 32 and not IAS 39, considering the backlash that the latter has had.

The ED postulates that financial instruments should be based on substance rather than form, compound instruments should be split into debit and equity and that the transaction cost on equity, net of any tax effect, would be a below-the-line adjustment.

The rather delicate topic of fair valuation has not been dwelt upon in depth. The negative reaction to IAS 39 would be a lesson to standard-setters the world over not to ignore reality when framing accounting standards that deviate from the tried and tested path. True convergence will occur when nil or limited options are given to presenters of financial statements to state their accounts.

The Chairman of the IASB, probably explained what should not be there in accounting standards when asked about what went wrong with IAS 39: "It's got lot of exceptions and exceptions to exceptions and it ring-fences them and looks terribly complicated. Accounting Standards should be framed in such a manner that 98 per cent of the people who want to use them understand them pretty easily". Hope this would be a harbinger of the times to come.

(The author is a Hyderabad-based chartered accountant.)

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