The Hindu Business Line : Recast the Schedule

THE Companies Act, 1956 has had a chequered career spanning nearly five decades. In the process, it has gone through turbulent times but has, by and large, managed to weather the storm. Frenetic global developments over the past decade has left this legislation completely out of sorts and outdated. Several provisions need a complete review to make the Act in tune with modern trends. One of the areas which requires immediate attention is the format of the balance-sheet, profit and loss (P&L) account and notes on accounts that accompany the statements. These are contained in parts I, II, III and IV of Schedule VI to the Act.

The format, which was set out way back in 1960, needs to be constantly upgraded to accommodate changes in legislation, the introduction of several accounting standards, the reporting requirements as per clause 49 of the listing agreement directed by the Securities & Exchange Board of India (SEBI), the accounting requirements spelt out by the RBI, wherever applicable, and the developments in accounting in US GAAP, International Accounting Standards (IAS), and so on. Ideally, the format should not be part of the Act but within the rule making powers so that constant revision is possible within the shortest period of time.

Balance-sheet format

Historical cost: The balance-sheet format is laid out in Part I, Schedule VI of the Act. Historically, this format suffers from accounting infirmities such as reflecting figures that are historical in its scope and not providing any indication of future trends. This is the case in all balance-sheets across the globe.

It has been said that only two elements in the balance-sheet are exact and real a) cash in hand; and b) share capital. All other components and elements suffer from the vagaries of estimation. Fixed assets are reflected at cost less accumulated depreciation.

Over the year, it has been seen that fixed assets in most balance-sheets are not exactly assets in the real sense, but liabilities to the organisation in question.

In evaluating the business at the time of takeover or sale, the present trend is to value the business independently and fixed assets separately to ensure proper valuation of the business and fixed assets respectively.

There is a clamour to reflect these assets at realistic current values on an ongoing basis. Some leeway is made in this direction, by providing for revaluation of assets and carrying of revaluation reserve on the liabilities side.

But this has not fully served the objective of restating fixed assets at current values. The new Accounting Standard (AS) 28, on `Impairment of Assets', would have to be accommodated in Part I, Schedule VI once the standard comes into force.

Brand valuation: While the format provides the facility of reflecting `goodwill' as the first item on the asset side, in modern business `brand valuation' is the order of the day.

For the accounting profession, valuation of brand has been a source of intense debate. The central theme of this debate is whether to introduce the value of brands in the balance-sheet.

One of the fundamental principles of accounting standards is that assets and liabilities should be recorded only if they can be reliably estimated. The accounting policy of not recognising self-generated brand is fair, given that there is lot of subjectivity in valuing brands, and recording brands in financial statements would impair reliability and comparability of financial statements.

As per International Accounting Standard (IAS) 38, on `Intangible Assets', internally generated brands cannot be recognised as intangible assets.

However, where a brand has been purchased at a price, the cost of the brand has to be allocated on a systematic basis over the best estimate of its useful life. The same principles have been set out in AS 26 (on `Intangible Assets') issued by the ICAI.

Even in the absence of AS 26, enterprises in the past could not bring in the books, the value of internally generated brands because AS 10 — on `Accounting for Fixed Assets' — prohibited the induction of self-generated goodwill (brand is a component of goodwill) in the financial statements. In view of these requirements, all enterprises in India that value internally generated brands were not introducing them in the balance-sheet (or even in the notes to the accounts).

It was, at best, being disclosed as additional information to shareholders. When companies/divisions are sold, the process of negotiations lays much emphasis on brand valuation.

In today's context, there is a need to revisit the concept of brand valuation and, perhaps, the time has come to put brand value figures on the balance-sheet. This requires legislative sanction.

Investments: The process of valuing investments has become cumbersome, complicated and, to a large extent, undependable. Investments are carried at cost and the current requirement mandates reflection of market value only as part of information or notes to accounts.

Companies are required to categorise investments as short term and long term and the basis of which these categorisations are made is spelt out in AS 13 (Accounting for Investment), prudential norms of the RBI, SEBI regulations, and so on.

There is much confusion in the realm of categorisation — whether as short term or long term, temporary or permanent, and so on. At present, adequate disclosures are not available scrip-wise for quoted investments, but only the total of quoted value is reflected in Schedule VI.

There is an immediate need for a re-look at valuation of investments for disclosure purposes and provide a scientific basis for diminution in the value of permanent investments held by the company. Despite several pronouncements and literature on the subject, all regulatory agencies should have a common consensus in the matter of valuation and disclosure of investments.

Research and development: With technology being the order of the day, companies are spending substantial sums in R&D and there is the ongoing controversy over whether such expenditure constitutes capital or revenue.

To add to this confusion is the treatment accorded to these expenses in income-tax assessments. As far as disclosure is concerned, Schedule VI, Part I should provide a specific item to reflect R&D costs.

At present, related costs are added to related fixed assets, but these get lost in the overall fixed assets schedule. A separate R&D disclosure is absolutely necessary, more so because AS 26 has been released (effective April 1, 2003), mandating companies to account for R&D costs in accordance with the standard.

Human resource: Companies have now openly accepted the value of human resource as part of financial information reporting. Most of the corporates attach more importance to human resources than any of the components of fixed assets. Valuation of human resources is a scientific process.

Infosys Technologies Ltd mainly uses the Lev & Schwartz model for human resource accounting. There are several other methods — such as Likert, Flamboltz and Jaggi — but Lev & Schwartz appears the most popular. Some Indian companies have voluntarily ascribed values for human resource and reflected the same as part of notes on accounts.

This trend, which is bound to be pronounced over a period of time, will have to be accommodated in the balance-sheet format itself.

Human resource will have to be undertaken on a year-to-year basis or at even shorter intervals depending on the requirements of the company.

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