The Institute of Chartered Accountants of India's new Accounting Standard 28 is set to hit the 2004-05 balance sheets and profits of a large number of companies that have not incorporated it in their quarterly numbers so far.
AS 28 provides for an asset (barring a few exceptions) as being "impaired" if its carrying amount (its market value after providing for depreciation) exceeds its value in use (present value of the expected cash flow from the use of assets) or net selling value (sale value minus cost of disposal).
In such a case, the asset value will have to be reduced to "value in use" or "net selling value," whichever is higher.
In other words, companies will now have to value every asset at the price it can be disposed of. The loss on account of this will be reflected in the profit and loss account of the same financial year.
AS-28 is meant to help companies focus on under-performing assets that are carried in their balance sheets and provide investors with an idea of how efficient companies are with respect to the use of capital.
Sudhir Soni, a partner at SR Batliboi & Co, said AS28, which was effective from April 1, 2004, would erode the net worth of some companies by as much as 25 per cent, "turning profits into losses".
All audit firms agree that this standard has the potential to create an uncomfortable situation for listed companies in terms of their financial statements.
"The opening reserves of companies will be hit as the transitional provisions provide for adjustment of earlier years' impairment through the reserves. Companies need to comply with the accounting standard, as otherwise, they will face qualification from the auditors in their annual report," ICAI President Kamlesh Vikamsey said.
On their part, several companies like Ceat, Ispat Industries and Bharti Shipyard maintained they would not be affected by the new rule. Tata Steel vice-president (finance) Koushik Chatterjee pointed out that companies were entitled to take impaired assets back on their books under certain circumstances.
"If there is a recession and the net present value is lower than the liquidation value, one has to provide for impaired assets. But if the cycle turns and the net present value is higher, a company is entitled to bring these assets back in its books."
Rajiv Memani, CEO and country managing partner, Ernst & Young India, said the 2004-05 profit and loss statement of companies would not be hit as most accounting standards gave companies the option to adjust changes against their reserves.
But accountants feel that the determination of the discount rate for future cash flows will be a crucial factor that will affect the profitability of companies.
There are some transitional provisions to this accounting standard. One of these is the adjustment of impairment losses against a company's reserves and consequential impact on deferred tax asset or liability. This means that when accounting for a loss, there is a question of how to deal with the deferred tax credit that arises.
A partner of a leading audit firm pointed out that AS-28's weakest factor was the subjectivity element in computing future cash flows, the discount rate, the estimated life of assets and the disposal value.
Bottom line blues
Valuing impaired assets under AS 28
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Asset value is value in use or net selling value, whichever is higher. Companies will now have to value every asset at the price it can be disposed of
Why AS 28
- To help firms focus on weak assets that are carried in their balance sheets
- Provide investors with an idea of how efficient firms are in the use of capital
