At a time when the entire country is discussing the fall of the rupee, the economic gloom and the incremental damage that the Food Security Bill would cause to the Indian economy, readers will wonder why I am discussing accounting reform.
The primary reason for the panic is the presumption that a year ago, the country had plenty of foreign exchange “reserves” and this was due to consistent economic growth. There is no dispute that India has come a long way since 1947, and the comparison of the rupee-dollar exchange rate in 1947, and that of today is preposterous. Having said that, it is necessary to read the figures that the government dishes out in the context of the cash method of accounting that it follows. If the government followed the accrual method of accounting which is mandatory for corporates, the government’s balance sheet would be significantly different. Three illustrations will make the point clear.
Any student of accounting will tell you that a “reserve” in the balance sheet is a surplus which is vested in the owner of the entity. In short, reserves are nothing but owned funds. The recent liberalisation of foreign exchange controls was on the basis that the foreign exchange “reserves” that the country had were here to stay. In fact, they constituted capital inflows which were parked in India on account of the non-availability of a better return elsewhere in the world. These capital inflows had the potential of being withdrawn and were therefore a debt. Till foreign exchange inflows arise either in the form of equity investment (FDI) or are the result of income accruals, they would not have any degree of permanence. If the balance sheet was drawn up bringing to the fore this aspect, people would have been cautious while celebrating economic growth.
The second illustration is that of funding through oil bonds or similar instruments. Since government accounting is on cash basis, the bonds or similar instruments are reflected as assets in the books of oil companies but the corresponding liability is not reflected as a liability in the government balance sheet. Thus, while shoring up the economy temporarily one is creating an unrecognised liability in the hope that during the tenure of this instrument income would accrue to the government enabling it to discharge the liability when it dawned on the horizon.
The third illustration is closer to our professional domain. We all know that targets for collection of tax are set by the powers that be on the basis of the past, oblivious to the fact that tax collections would depend on the economic situation which has shown a gradual decline in the recent past. In the race to meet these irrational targets the tax authorities raise patently illegal tax demands and by misusing powers forcibly collect them as well. These collected disputed demands often constitute a liability of the government and are not its income. Though the judicial system in India is afflicted by many ills, it still functions. Consequently, many of the high-pitched demands are deleted in appeals and result in refunds. The target however is based on the tax collected in the preceding year resulting in the authorities creating further high-pitched demands which have a cascading effect. Everyone is busy passing the buck without coming to terms with reality.
The accounting and auditing profession is a much maligned profession. The auditor is restrained by the regulations of his profession and is therefore not able to defend himself in public. If analysts and regulators had paid adequate attention to what auditors report and had taken timely action, at least some of the economic disasters could have been avoided.
I believe that the accounting profession has a very important role to play in ensuring that the state of the economy is transparently put in the public domain. The first step in this direction is for the government to shift from the cash system to the accrual system. The process has begun, with an attempt to convert accounting of urban local bodies to double entry system, but the progress is agonisingly slow. This is for the reason that many of those involved in governance do not appreciate the significance of the change in method of accounting and the benefits thereof. It is treated as a low priority item on the agenda to be dealt with only if time permits. The other possibility is that they feign indifference because they are conscious that if the accrual method of accounting is followed, the picture of the economy may darken further.
The government continuously exhorts businesses to follow “global standards”. It needs to practice what it preaches. The government of New Zealand makes its financial statements public. The audited statements for the year ended 30th June 2012 are available on the government website. These have been prepared on accrual basis. The statements for the 11 months ended 31st May 2013, were released on 5th July 2013. Those interested may visit the website – www.treasury.govt.nz. I am conscious that New Zealand and India are not comparable. I have given the illustration only to establish that what is being suggested is possible. If we have the desire we will get there. But if we have to reach the goal we have to make a beginning. We are already late. The time to start is now!
Anil J. Sathe
Editor
