Old accountants never die; they just get out of balance

Pallav Gupta

“If two equally profitable firms, one German and one American, acquire comparable firms that have
identical goodwill, the US firm will report a much lower profit than the German firm, because of
differences in accounting conventions regarding goodwill”.

Daimler-Benz, a leading German firm, decided in 1993 to list on the

NYSE. Towards this end, it issued two sets of accounts, one adhering to
the German GAAP and the other adhering to the US GAAP. When Benz
announced its 1994 financials, the inconsistency between the German
GAAP and the US GAAP was revealed. Under the German GAAP, Benz
reported a profit of USD 100 million plus but under the US GAAP, it
reported a loss of USD 1 billion (yes, 1000 million)!

W A Wallace and J Walsh (vide, “Apples to Apples: Profits Abroad“, Financial Executive, May-June 1995,
pp. 28-31) conducted a study to quantify the extent of differences by comparing various accounting
measures and profitability ratios across 22 developed nations. They found that among the 22 countries,
there were 76 differences in the way cost of goods sold was assessed, 65 differences in the assessment
of return on assets, 54 differences in the measurement of research and development expenses as a
percentage of sales and 20 differences in the calculation of net profit margin. In the circumstances, it is
almost impossible to compare the financial performance of firms based in different nations.

There is a saying, “Old accountants never die; they just get out of balance.” One could probably tweak
that a bit and say: “Old accounting standards never die; they are changed with the changing times.”

The idea of global harmonization of accounting standards stems from lack of comparability of financial
statement across countries. In particular, a company having presence in different countries has to
prepare financial reports as per generally accepted accounting principle of the country of operation and
then it is required to reconcile all such reports for the purpose of consolidation as per GAAP of the
country to which the parent belongs. This increase the cost of preparing the financial report and also
performance measurement across the geographical region becomes difficult because of non-
comparable accounting rules. The expanding globalization of business and investment is driving increase
interest and as well as pressure, to enhance the quality of financial reporting throughout the world – to
compare apples with apples, so to speak- so that effective evaluation between companies can be made.

India will adopt the globally accepted International Financial Reporting Standards (IFRS), formulated by
UK-based International Accounting Standard Board (IASB) which came into being in March 2001,
replacing the International Accounting Standards Committee (IASC), which came into being in 1973, by
2011, a move that will integrate the accounting system with the rest of the world. More than 109
countries, including China, have adopted IFRS and many more like Japan, US, Canada and South Korea is
expected to follow suit.

It is just as well that the government of India has decided to adopt international accounting guidelines.
Otherwise, almost 200 Indian firms listed on European bourses would have been put to hardship owing
to differences in Indian and EU (European Union) accounting norms. These firms have raised capital
from EU investors. If the government of India had not agreed to adopt international accounting
guidelines, the EU may have initiated tough action against the said firms for non-compliance with
internationally-accepted accounting standards. The firms may have been obliged to be de-list from EU
exchanges or have their books re-audited by European audit firms. The latter action would have
increased the compliance cost for the firms significantly. After all, Indian firms are the largest non-EU
entities to have raised capital from the trading block.

The government’s action results from EU’s announcement that it would examine the equivalence of
accounting standards followed by non-EU countries during 2008. It would spare firms from tough action
only if the home countries of the firms adopted a convergence program. In the circumstances, the
government of India wanted to clearly convey to EU that it intends to converge with international
financial reporting standards (IFRS) by 2011. Given that India has already adopted a program of
convergence with IFRS, a public confirmation of the approach leading to convergence with IFRS would
enable EU to determine the equivalence of Indian accounting standards.

Is this metamorphosis of standards merely due to EU pressure on India or India is ready to adopt it???

A recent survey in Canada (which is also seeking a 2011 IFRS adoption) indicated that more than 80 per
cent of companies had already understood the impact of IFRS adoption and had well laid-out plans to
achieve implementation. It is expected that similar preparedness within corporate India would currently
be less than 1 per cent.