‘Transactions of auto sector could come under scanner
Business Line: July 2,2008
Chennai: That’s the message which may ring loud and clear once the IFRS (International Financial Reporting Standards) alignment happens in India Inc by 2011, as announced by the Institute of Chartered Accountants of India. With high interest rates and higher input costs already puncturing their fortunes, will India’s automotive sector then be in for a skid? “The automotive sector enters into various transactions which could come under scanner when proposed Accounting Standard 30 (AS 30) on ‘Financial instruments – measurement and disclosure’ becomes fully effective,” says Mr Pankaj Chadha, Director, Ernst & Young India. To know more, read his Q&A with Business Line done over email.
Edited excerpts.
Why should the auto sector become careful?
The automotive sector enters into various transactions which could come under scanner when AS 30 becomes fully effective. This might take some time considering the differences in accounting arising out of what this standard proposes with current practices as included in many other mandatory standards.
It is necessary for auto companies to be aware of these requirements in order to allow better planning and effective structuring. This becomes imperative bearing in mind significant inbound and outbound investment activities where the other party is operating in an IFRS-compliant country. Most investment activities in the auto sector are with the US, the EU and Japan. While the US follow the US GAAP, the EU and Japan (and even India by April 2011) are on IFRS.
You mean to say that IFRS-Indian GAAP differences could be a problem?
Yes. Thorough thought needs to be given when reviewing IFRS differences with Indian GAAP such as financial instruments which will require close deliberation and most preparation from a financial planning perspective.
All risks for which a hedging instrument (‘marketable’ or ‘non-marketable’; other than hedge through insurance) is available would require fair value assessment rather than the current basis of recording these transactions on historical costs.
Whether it is common exchange rate risk, stock indices risk, commodity price risk or loan interest risk, the proposed standard would require fair value assessment for measurement and more extensive disclosure explaining hedging principles followed by the corporate.
How are auto companies exposed?
Most commonly used hedge instruments that automotive companies obtain include exchange rate hedge, commodity price hedge, loan interest rate hedge, credit term hedge or supplier price hedge. Whilst in most cases, mark to market data is available for companies to assess the impact of losses (and gains) out of these instruments, hedges for supplier price or credit term would need to be examined using complex valuation models. Even in cases where market data is available it is not from mature and reliable markets, leaving room for subjectivity. The ICAI recommended early adoption of AS 30 for accounting periods ending on March 31, 2008, or alternatively record losses (on grounds of prudence) from such instruments till the time AS 30 is applied.
Will this affect future investments too?
For an intelligent investment decision to be made, by an auto or any other company, a detailed and thorough review is necessary, with appropriate consideration of long term impact of these changes on the forecasts and budgets of the company. Not only restructuring of certain hedges but also better negotiations with traders would be necessary. This would entail companies to review their treasury organisation and strengthen it to ensure that ‘smart’ proposals are better examined with knowledge of the requirements of the accounting standards.
What should the auto companies do?
It is important that quick action be planned by auto companies. IT systems, training of people, evaluation of taxes (including deferred taxes) are just some of the areas where focused investment is necessary. Future results for business valuations will also need to give consideration to the fair value principles proposed in the standard as well as other requirements under IFRS. Indian corporates would need to be ready for IFRS implementation in not-so-distant time. In fact, the time has arrived for companies seeking investment or making investment to base their decisions on IFRS forecast results.
