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AND AUDITING
UPDATE
January 2011
Editorial
First of all, we would like to wish you all a happy new year 2011. It is with
immense pleasure we bring forth the January 2011 edition of the Accounting
and Auditing Update.
The Companies Bill, 2009 (Bill), which seeks to replace the age old
Companies Act, 1956 was introduced in the Lok Sabha on 3 August 2009 and
subsequently referred to the Standing Committee on Finance of Parliament
(Committee) for a detailed examination. The Committee, through its report
dated 31 August 2010, has made certain game changing recommendations
which include: (1) extending the need to appoint independent directors to Narayanan Balakrishnan
certain unlisted companies (2) mandating the selection of independent Executive Director
directors out of a databank to be maintained by the Ministry of Corporate KPMG in India
The IASB and FASB are jointly developing a standard on financial statement
presentation to address user concerns that the financial statements are
presented in an overly-aggregated fashion and often times inconsistently
presented across the various statements within a set of financial statements.
In this connection, the boards have issued a Staff Draft which proposes the
need to classify assets, liabilities, revenues and expenses under the
operating, investing, financing categories with separate sections for taxes
and discontinued operations. The Staff Draft also mandates the direct method
of preparing the cash flow statements and the need for presenting
disaggregated information on costs by function as well as the nature of the
financial statements. Preliminary estimates indicate that companies may
incur significant implementation costs to conform to the new format, as
changes to systems, processes, and internal control policies and procedures
are likely to be inevitable.
On 21 July 2010, the US President, Barack Obama signed into law the Dodd-
Frank Wall Street Reform and Consumer Protection Act of 2010 which is
acknowledged to be a sweeping overhaul of US financial regulation since the
1930s. Despite running into 2,300 pages, it leaves much to be fleshed out by
future rule making. Apart from significantly impacting the financial services
community, the Dodd Frank Act also enhances protection to whistle-blowers
and other informants of the Securities Law violations. Additionally, the Act
provides for a claw-back of compensation given to current and former named
executive officers in the event of a financial statement restatement
irrespective of whether the restatements arose as a result of misconduct. In
this publication, we have attempted to summarise the impact of Dodd Frank
Act specifically from the perspective of a Foreign Private Issuer.
Future!
Financial statement presentation 13
Dodd-Frank Act
Snapshot of Implications for Indian Foreign Private Issuers 20
Regulatory Updates 25
An analysis of the
report of Standing
Committee on
Companies Bill,
2009
The Companies Bill, 2009 (Bill) was
introduced in Lok Sabha on 3 August 2009
and subsequently on 9 September 2009,
it was referred to the Standing Committee
on Finance of Parliament (Committee) for
its detailed examination and report.1 The
report of Standing Committee was
presented to the Lok Sabha on 31 August
2010 and laid in the Rajya Sabha on the
same date1.
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2
The essence of the Bill is to facilitate a changes therein as agreed to by the The report of the Standing Committee
comprehensive revision of the present Ministry of Corporate Affairs (MCA), on the Bill contains a large number of
Companies Act, 1956 with a view to seeks to bring about vis-à-vis the recommendations. It is not possible to
promote self-regulation, eradicate position obtaining as at present. The deal with each and every such
unwarranted regulatory approvals, vest focus is primarily on proposals which recommendation due to limitation of
shareholders with greater powers and have been significantly amended during space. The following discussion is,
encourage greater transparency in the the process of the Committee’s therefore, only with reference to some
disclosures by corporate entities. consideration. The analysis identifies of the major recommendations and is
Corporate governance is one aspect the proposed departures from the by no means exhaustive.
where heightened emphasis has been existing position, their potential
given to ensure accountability of benefits, and the challenges that those
individuals at the helm of affairs of a changes are likely to create. It may be
company. worthwhile to add that the Report
leaves many issues for further
In the following paragraphs, we have
consideration of the MCA and
attempted an analysis of some of the
therefore, there is a possibility of some
principal changes relating to corporate
further changes.
governance that the Bill, read with the
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3
Benefits Challenges
• Independent directors help to counterbalance the • The proposal seeks to strengthen the independence
natural potential for conflict between the interests of independent directors. However, the concept of
of executive directors and shareholders and other independence is multifaceted, judgmental and
stakeholders. highly subjective.
• A central databank will provide a readily accessible • Maintenance of a panel may give rise to concerns
pool of eminent qualified personnel and of favouritism and bureaucratic delays unless the
professional experts who would be able to share empanelment criteria are objective and publicly
their enriching knowledge and provide valuable known and other checks and balances are put in
insights based on their experience from other place.
reputed companies where they have served, or are • Evaluating a person's competence, integrity and
serving, as independent directors. This will also commitment is not always possible on the basis of
facilitate incorporation of best industry practices. information available in a databank.
• Whilst selection is to take place from the panel, the • It may so happen that certain highly reputed and
power to select or choose the independent eminent individuals fail to register their names
directors still vests with the company and to this either unintentionally or intentionally. This would
extent, there is no major change/dilution in the prevent companies to choose such people because
company’s powers. of the statutory requirement.
• Considering that the criteria for determining
independence have in any case been specified,
constitution of a panel may unduly complicate the
appointment process.
“Whilst having a panel to choose from provides increased flexibility and facilitates uniformity in
the selection process, whether such a benefit justifies a rigid appointment process is open to
debate”
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Benefits Challenges
• Having a limit on the tenure of office seems to have • Having a restricted tenure could prove to be
merit since the ability of an independent director to counter-productive since the knowledge gained
act independently may be impaired if the through experience may not be fully put to use in a
association with a company continues uninterrupted shortened tenure.
for a significant extended period. However, it is a • A restricted tenure could also affect the enthusiasm
moot point whether the limit of six years is the and effectiveness with which an independent
appropriate limit. director provides suggestions for high-level
• A new set of people would have a fresh perspective decisions to be taken by the Board.
and outlook to company’s issues and would also be • There exists no uniformity in various regulatory
more likely to objectively evaluate the practices guidelines with respect to maximum number of
being followed. years as tenure by an independent director and
there is genuine doubt on what is an appropriate
period.
• Given that a director would usually take a year or
two to be familiar with the dynamics of a company,
the functioning of the board etc., a term greater
than six years or a term which may be fixed (within
reasonable limits) by the company may be more
appropriate.
“There is a need to strike balance between maintaining the independence and ensuring
effectiveness of an independent director”
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5
Benefits Challenges
• This would ensure that a company spreads the • Companies do business to create value addition to
benefits generated from its operations across the their shareholders. This has to be the first and
overall society to which it belongs, thereby foremost objective for any company. Mandating the
achieving a macro level objective of contributing to CSR initiatives could result in conflict between the
the society. economic and social objectives of a company.
• This would facilitate effective initiatives by public- • Companies already cater to the needs of various
private enterprises jointly coming together instead sections of the society by providing employment,
of only the state being made responsible for the paying taxes to government, sustaining
welfare of society. developmental activities in the surrounding areas
• The requirement for a company to give adequate etc. To thrust more responsibility on them by way of
disclosures on its CSR initiatives or reasons for non- mandatory CSR initiatives could discourage
compliance would keep the shareholders and other corporate world.
users of financial statements sufficiently informed. • Effectively, this would amount to corporate income
tax rate going up by 2 percent.
• Mandating a specific budget for CSR initiatives may
be counter productive. Companies should be
encouraged to voluntarily adopt good governance
and corporate social responsibility practices, rather
than be legally compelled to do so.
“Imperative need to strike a balance between socially responsible behaviour and economic
objectives of the corporate world”
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6
Rotation of auditors
“In the absence of a strong case for audit firm rotation, the international experience should be
leveraged to introduce alternative mechanisms to safeguard the independence of auditors”
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7
Benefits Challenges
The requirement would ensure that the audit Independence being a subjective concept is difficult to
committees develop procedures to regularly review establish. The ways and means by which audit
whether the auditor has remained objective and committee can ensure independence are limited.
independent in discharge of his duties. Many audit committees may just obtain a letter from
the auditor regarding compliance with independence
requirements.
• The CFO shall be responsible for the proper The present Act does not specifically recognise the
maintenance of the books of account of the company, position of the CFO. However, the SEBI listing
and shall ensure proper disclosure of all required requirements stipulate certain specific functions for the
financial information indicated in the prospectus or any CFO. In practice, CFO is responsible for most of the
other document, risk management, internal control above activities and reports to the Board.
“Striking the right chord between CFO’s responsibilities & powers vested in him is a need of
the hour”
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8
Auditors’ report
“Whilst making the auditors comment on compliance with internal controls by listed companies
is a laudable step, scope for improvement does exist to have greater impact”
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9
Benefits Challenges
Participating by video conferencing (or similar means) The Board meetings are forums where directors carry
is a very welcome step and would ensure greater out numerous discussions on the company, all of
participation of directors and also save time and cost. which may not be recorded for various reasons.
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10
Benefits Challenges
• Stock-option compensation can have negative • The present practice is stringent enough, requiring
effects since it could compromise the wide-ranging disclosures in company’s financial
independence of independent directors by shifting statements and other public documents, for stock
their focus on short-term stock price movement options given to the directors including the
instead of promoting long-term interests of independent directors. More importantly, these
stakeholders. stock options are subject to approval of the
• The mechanism of stock options is such that lower shareholders of the company.
the stock price on the grant date, more likely the • If it is argued that independence is enhanced by
recipient would be to gain. This may lead in some preventing independent directors from having stock
cases to time the grants in such a way so as to suit options, questions arise as to why only
the convenience of directors. independent directors should be prevented from
having stock options and why not other directors
who form part of the board and who have greater
powers in driving the operating policy decisions of
the company.
• Various countries (USA, UK, Canada, Australia,
Singapore, Hong Kong to name some) do not
prohibit stock options for independent directors.
Considering that stock option consideration is
growing in popularity, it may be more appropriate
to place restrictions either on the total amount of
options or on the manner of vesting and exercise
of such options and sale of resultant shares.
“Restricting independent directors from being granted stock options needs further debate“
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Benefits Challenges
• Brings about uniformity which would facilitate • Global companies generally follow calendar year as
better comparison of financial statements of their financial year. Also, Indian companies with
companies. subsidiaries across the world could have different
• The Income-tax Act, 1961 has already brought in financial years across these subsidiaries. The
the concept of a uniform financial year of April – proposed recommendation could lead to problems
March consequent to which most of the in consolidation process.
companies already have April–March as financial • The proposed change allows companies to make
year. an application to Tribunal and seek its approval for
following a different period. In today’s world,
companies look towards support from the state in
reducing administrative hassles involved in
obtaining approvals from government regulatory
bodies. This change would largely be looked upon
by the corporate world as increasing their burden.
“It would be necessary to lay down procedures whereby applications seeking approval in this
regard are processed expeditiously”
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2011 KPMG, an Indian
an Indian Partnership
Partnership and a member
and a member firm offirm of the KPMG
the KPMG network network of independent
of independent membermember firms affiliated
firms affiliated with with
KPMG KPMG International
International Cooperative
Cooperative (“KPMG(“KPMG International”),
International”), a Swissa entity.
Swiss entity. All reserved.
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12
Summary
Given the likely pervasive impact of the provisions
of the Bill, the need of the hour is to strike the
appropriate balance to achieve the twin objectives
of improving corporate governance without creating
undue bottlenecks. It is expected that the benefits
and challenges of the new proposals will be
appropriately deliberated and addressed prior to
enactment of the final legislation.
© 2011©KPMG,
2011 KPMG, an Indian
an Indian Partnership
Partnership and a member
and a member firm offirm of the KPMG
the KPMG network network of independent
of independent membermember firms affiliated
firms affiliated with with
KPMG KPMG International
International Cooperative
Cooperative (“KPMG(“KPMG International”),
International”), a Swissa entity.
Swiss entity. All reserved.
All rights rights reserved.
13
FUTURE!
FINANCIAL STATEMENT PRESENTATION
The primary objective of this project is to establish a global standard that will On 1 July 2010 the IASB and the FASB
guide the organisation and presentation of information in the financial posted to their websites a staff draft of
statements. The boards' goal is to improve the usefulness of the financial proposed standard that reflect tentative
information to assist management to better communicate its financial decisions made to date, as a basis for
information to the users of its financial statements and to help them in decision extended stakeholder outreach
making. activities.
The financial statement presentation project is being conducted in three main However, work on the project is
phases as below: continuing, and the proposals are
subject to change before the boards
Phases Status decide to publish an exposure draft for
public comment.
Phase A: IAS 1 The IASB issued a revised version of IAS 1 in September 2007
Financial Statement
Presentation
completed
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14
WORK
TOGETHER
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Consistent with the cohesiveness Financing section • all changes in equity in the statement
principle, all related effects from those of changes in equity and
The financing section would include
liabilities would be classified in a similar • all cash flows related to equity
items that are part of an entity's
subcategory in the statement of transactions in the financing section
activities to obtain (or repay) capital.
comprehensive income. However, of the statement of cash flows.
The financing section is expected to
related cash flows would be presented
provide transparency about an entity's
in the operating category in the
capital structure and the financing
statement of cash flows which does
activities in which the entity engages.
not include an operating finance
The financing activities would be Our comments:
subcategory.
grouped into tow categories: debt and
It is not clear whether
The investing category would include equity in the statements of financial
transactions under IFRS 2,
assets or liability that an entity uses to position and comprehensive income.
Share-based Payment would
generate a return and any change in However, in the statement of cash
be classified under the debt
those assets or liabilities. No significant flows the financing activities will be
category. One could
synergies are created for the entity by separated into debt or equity.
understand that cash settled
combining an asset or a liability
The debt category would include: share-based payments
classified in the investing category with
should be shown in the debt
other resources of the entity. An asset • borrowing arrangements entered into
category whereas it is not
or a liability classified in the investing for the purpose of obtaining or
clear in which category
category may yield a return for the repaying capital and the related
expenses resulting from
entity in the form of, for example, income effects and
equity settled share-based
interest, dividends, royalties, equity • transactions involving an entity's own payments should be shown.
income, gains or losses. equity, including the assets, liabilities Further, these transactions
and related income effects that arise may not always be debt and
from these transactions. may instead meet the
Our comments: definition of equity in IAS 32,
Transactions involving entity's own
It is not clear from the equity would be presented separately Financial Instruments:
requirements of the staff draft from the borrowing arrangements with Presentation and IFRS 2 for
where goodwill should be the debt category. example, by delivering a
presented. It seems that fixed number of shares which
goodwill should be classified The equity category would include are equity-settled share-
in the operating category of • all equity items as determined in based payments.
the business section; however IFRS in the equity category of the
some may argue that it statement of financial position
should be classified in the
investing category of that
section.
There is a disconnect in
relation to the operating
finance subcategory in that it
appears in both the statement
of financial position and the
statement of comprehensive
income but not in the
statement of cash flows.
Some question if finance
lease will always be
classified as operating
finance lease liabilities. For
example, if an entity enters
into a sale and finance lease
back transaction as a means
of raising funds or for tax
planning purposes and such
property is not used in the
day-to-day business, would
the finance lease liability still
be classified in the operating
finance sub-category?
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19
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20
Dodd-Frank Act
Snapshot of Implications for Indian
foreign private issuers
Economic growth results in an inevitable need for legislators to formulate
new legislations and laws to adapt to the changing environment and to
ensure that its constituents do not attempt to take advantage of lacuna in the
prevailing compliance framework. In today’s world, cutting edge competition
in corporate sector coupled with misplaced priorities on economic values over
ethical values have led to numerous corporate scandals being witnessed
across the globe.
The prevailing laws and legislations in a society get outgrown over time which
necessitates introduction of newer and more effective legislation to suit the
evolving needs. The introduction of the Dodd-Frank Act is yet another step in
this direction in an endeavor to redefine the concept of ‘regulations and
reforms’ not only in financial services sector but also in all other sectors both
within United States and to a lesser extent outside the US as well.
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22
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23
The Dodd-Frank Act seeks to curtail application of the recent Key provisions relate to setting up of a board to ensure
Supreme Court decision in the US in Morrison vs National governance, documentation and implementation of effective
Australia Bank Ltd., in which it was held by the court that system of internal controls for determining ratings,
the anti-fraud provisions laid down in the Section 10 of the requirement for a compliance officer and fixation of their
Exchange Act were not applicable to private actions by compensation independent of organisation’s financial
foreign investors arising from purchases and sales of performance, establishment of rules on reporting of
securities that occurred outside the US. In essence, this employments of senior officers associated with the rating
would have considerable effect with respect to foreign agencies, ensuring greater transparency in rating
cubed cases. i.e., cases involving non-US investors who procedures and methodologies etc.
have purchased non-US securities on non-US stock “Provisions in the Act would prevent mushrooming of
exchanges, so long as there exists significant steps in undesirable practices in such ratings organisations”
furtherance of violation within the US. Thus, the Act could
results in extension of the Federal district courts’ jurisdiction
and allows enforcement actions to be brought in US courts 9. Independent compensation
for such foreign cubed cases also if the criteria stipulated in committee
the Act are fulfilled.
The Dodd Frank Act has focused on addressing the norm
“Whilst the extraterritorial jurisdiction casts the net surrounding independence and functions of compensation
wide open across non US countries, practical committees. Even though the Nasdaq/NYSE rules require
application remains to be seen as it depends on that executive compensation at listed companies get
flexibility provided by statutes of non US countries” determined or recommended to the full board for
determination solely by independent directors or an
independent compensation committee, no provision in the
6. Disclosure of internal pay ratio Exchange Act or any SEC rule mandated full independence
The Dodd-Frank Act directs SEC to amend Item 402 of of compensation committee.
Regulation S-K requiring companies to disclose the median Section 952 stipulates that this requirement relating to
of the annual total compensation of all employees of the independent compensation committee is not applicable to
company (other than the CEO) as well as the annual total FPIs that provide their shareholders with annual disclosure
compensation of the CEO. Companies must then also of the reasons why they do not have a fully independent
provide a ratio comparing those two figures. compensation committee. Therefore, to this extent, this
There exists some bit of confusion on whether this amendment by the Dodd-Frank Act has limited applicability
disclosure requirement applies for a foreign private issuer or to FPIs.
not. However, the Act directs the SEC to amend Item 402 to “Necessitating independence of compensation
require this disclosure in any filings “described in Section committee is a right step in the right direction”
10(a)”, which goes beyond proxy statements and annual
reports on Form 10-K. i.e., it also include annual reports filed
under Form 20-F by foreign private issuers.
“SEC’s course of action on this disclosure requirement
for foreign private issuers is awaited in this regard ”
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24
10. Broker discretionary voting The Dodd-Frank Act further limits discretionary voting by
brokers, by requiring all national securities exchanges to
The Dodd-Frank Act has introduced additional limits on the adopt standards prohibiting discretionary broker voting in
ability to vote shares in the absence of direction from elections, as well as in connection with executive
beneficial owners. Shares which brokers hold on behalf of compensation or any other significant matter, as determined
beneficial owners are generally voted by such brokers in by SEC rulemaking. This empowers the SEC to determine
accordance with the instructions given by the beneficial other matters where it would want the brokers to not
owners. When such beneficial owners do not provide any exercise their discretionary voting rights.
instructions on voting, the New York Stock Exchange (NYSE)
rule 452 permits member firms to vote in their discretion on
certain routine matters. Subsequently, the NYSE rule 452
was amended effective January 2010 to prohibit broker
discretionary authority to vote on director elections, even if
uncontested.
Conclusion
Having discussed some of the significant impact on foreign private issuers pursuant
to Dodd-Frank provisions, it is to be seen how future rulemaking will set the tone.
The application of provisions laid out by the Dodd-Frank Act would not only require
various federal agencies to adopt new rules and amend existing ones, but also might
pose implementation challenges. Consequently, the world needs to await whether
the rules implementing the Act in the days to come, would also include exemptions
and relaxations for specific category of companies such as foreign private issuers
and smaller reporting companies to facilitate effective implementation.
Even though, there exists shades of difficulties which might be encountered upon
implementation of some of the provisions of the Dodd-Frank Act, the larger truth
lays in understanding the essence of the Act and the spirit it manifests. Like its
predecessor ‘the Sarbanes-Oxley Act’, the Dodd-Frank Act is here to stay for more
than one reason and it would augur well for the corporate sector and its participants
to understand this not-so bitter truth and welcome it wholeheartedly.
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25
REGULATORY UPDATES
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SEBI (Issue of Capital and Disclosure Sale of investments held under Held to
Requirements) (Fourth Amendment) Maturity (HTM) category
Regulations, 2010 As per the existing requirements, if the value of sales and
Securities Exchange Board of India (SEBI) has introduced a transfers of securities to/from HTM category exceeds 5
requirement to publish proforma financial statements, if: percent of the book value of investments held in HTM
category at the beginning of the year, banks are required to
an acquisition
? or divestment is made by the issuer after
disclose the market value of the investments held in the
the end of the latest disclosed annual financial results in
HTM category and indicate the excess of book value over
the offer document, due to which certain companies
market value for which provision is not made.
become/cease to be direct or indirect subsidiaries of the
issuer and With regard to the above, the RBI has clarified that the
following would be excluded from the prescribed cap (i.e.,
the financial
? statements of such acquired or divested
five percent of the book value of investments):-
entity is material to the financial statements of the issuer
company. one-time transfer of securities to/from HTM category
?
permitted by the Board of Directors to be undertaken by
Where the said acquisition or divestment does not fulfil the
banks at the beginning of the accounting year and
tests of materiality, the fact of the acquisition or divestment
along with the consideration paid/received and the mode of sales to the Reserve Bank of India under pre-announced
?
financing such acquisition shall be disclosed. The above open market operation auctions.
information shall be certified by the statutory auditor of the
The clarification is effective from 1 April 2011.
issuer. These Regulations are effective from 12 November
2010. The circular intends to reduce the disclosure requirements
of the banks when such transfers are on account of
The said disclosure requirement is in the wake of SEBI’s
startegic decision made by the Board at the beignning of
hardened stance on disclosure requirements of keeping the
the accounting year or at the direction of the RBI.
prospective investors informed about the significant
changes in the financial positions of the company post the (Source: DBOD. No. BP.BC. 56 /21.04.141/2010-11 issued by RBI, dated
date of offer document. This will give additional qualitative 1 November 2010)
factors to the prospective investors for making investments
decision before close of the offer.
One may refer to www.sebi.gov.in for further details.
(Source: notification dated 12 November 2010 issued by SEBI)
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MISSED AN ISSUE OF
ACCOUNTING AND AUDITING UPDATE?
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