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CORPORATE GOVERNANCE
AND
ACCOUNTING STANDARDS IN INDIA:
AN EMPIRICAL STUDY ON PRACTICES
DR.K.SHANKARAIAH *
D.N. RAO**
ABSTRACT
The good Corporate Governance ensures the better corporate performance and better
relationship with stakeholders, where the proper practice of accounting standards leads to
the effective disclosure thus, good Corporate Governance. Hence, the practice of proper
accounting standards is more relevant issue of good Corporate Governance. In India, the
accounting standards are under the developing stage gives more scope for the personal
discretion, hence, the disclosure is ineffective. In view of the liberalization and
globalization of the Indian economy, the formulation, development and practice of the
proper accounting standards and reduction of the gap between Indian and International
Accounting Standards are very much needed to ensure a good Corporate Governance in
the present Indian context.
In this context, an attempt is made in this paper to discuss the practice of accounting
standards for good Corporate Governance, as it is regarded as one of the important
relevant issues of Corporate Governance, with an objective to make the accounting
standards useful to ensure the better disclosure, thus the good Corporate Governance.
*Associate Professor, Department of Commerce, Osmania
University, Hyderabad – 500 007, A.P. India.
**Faculty Member, College of Commerce & Economics, Sultan Qaboos
University, Sultanate of Oman.
1
CORPORATE GOVERNANCE
AND
ACCOUNTING STANDARDS IN INDIA:
AN EMPIRICAL STUDY ON PRACTICES
DR.K.SHANKARAIAH *
D.N. RAO**
RELEVANCE:
In recent years, the Indian economy has undergone a number of reforms,
resulting in a more market-oriented economy. Particularly, after the
Government of India has taken steps towards liberalization and globalization
of the economy, the size of Indian corporates is becoming much bigger and
accordingly the expectations of various stakeholders are also increasing,
which can be satisfied only by the good Corporate Governance.
The importance of good Corporate Governance has also been increasingly
recognized for improving the firm’s competitiveness, better corporate
performance and better relationship with all stakeholders(1), because of which
the Indian Corporates have obliged to reform their principles of Governance.
For that purpose, Indian companies will now be required to make more and
more elaborate disclosures than have been making hitherto, for which they are
also required to adhere to the uniform and proper accounting standards, as the
standards reduce discretion, discrepancy and improves the utility of the
disclosure.
*Associate Professor, Department of Commerce, Osmania University,
Hyderabad – 500 007, A.P. India.
**Faculty Member, College of Commerce & Economics, Sultan Qaboos
University, Sultanate of Oman.
2
Here, the Corporate Governance is a voluntary, ethical code of business
concerned with the morals, ethics, values, parameters, conduct and behavior
of the company and its management. The corporate responsibility begins with
the directors who are the mind and soul of the organization. The Board is
expected to act as conscience-keeper of the corporate vision and mission, and
devise the right type of systems for organizational effectiveness and
satisfaction of stakeholders. Thus, the Corporate Governance is a system of
accountability primarily directed towards the shareholders in addition to
maximizing the shareholders’ welfare(2), where the debate on disclosure/
transparency issues of Corporate Governance eventually centres around the
proper accounting standards, their practices and issues, as the application of
accounting standards give a lot of confidence to the corporate management
and the disclosure would be more effective and ensure the good Corporate
Governance . Thus, the study of practices of accounting standards is an
important and relevant issue of good Corporate Governance in the present
environment, as the standards are viewed as a technical response to call for
better financial accounting and reporting; or as a reflection of a society’s
changing expectations of corporate behavior and a vehicle in social and
political monitoring and control of the enterprise(3).
STUDY:
In India accounting standards are inadequate, as a result the disclosure is
ineffective, which is a negative phenomenon to a country which wishes to be a
global player as it cannot hope to tap the GDR market with inadequate
financial disclosures, since the more transparent activities of a company
governed by the proper accounting standards, the more accurately will its
securities be valued(4).
The old ways of selective and conservative reporting is yielding place to more
transparent and voluntary disclosures, in tune with the changing times.
Therefore, there is no alternative to adopting by the corporate entities of new
standards of accountability, where the accountability is largely a matter of
disclosure, of transparency, of explaining a company’s activities to those to
whom the company has responsibilities(5) i.e. the disclosure in simple,
3
understandable and comparable form, forms clearly the basis for
accountability, which can be provided only if companies adopt uniform
accounting policies and disclose adequate information about the accounting
standards followed. Thus, accounting standards ensure the comprehensive
disclosure of the corporate's accountability, which may be regarded as a prime
issue and a pre requisite for good Corporate Governance.
An examination of practices of accounting standards, and their issues in
Indian industry may help to understand the existing practices of accounting
standards, which in turn help in designing the effective standard practices so
as to ensure good Corporate Governance.
In this context, an attempt is made here to examine the accounting standards
and their practices in India, with a view to strengthen the accounting standards
and improve their practices for good Corporate Governance. The data for the
study are obtained from the annual reports (published during 1998-’99) of
forty Indian companies of different nature, selected from the top 100
companies in terms of assets. The sample consists of 24 private and 16 public
limited companies . The simple per centage method is used to analyze the
data. The authenticity of the data is verified with the opinions of management,
who are aware of the company affairs and Corporate Governance. The
corporates’ perceptions on the relevance of accounting standards for good
Corporate Governance in Indian context are also examined.
ACCOUNTING STANDARDS IN INDIA:
In any country, the awareness and competitiveness among the corporates
would be strengthened when they understand each other and compare their
performance, for which the simple, understandable and comparable disclosure
is an important instrument. The main objective of disclosure would be
fulfilled and the utility of the disclosure towards good Corporate Governance
would be improved when the disclosure is done on the basis of uniform and
consistent accounting standards. Thus, the development and the practice of
uniform accounting standards is an essential essence of Corporate
4
Governance, for which various bodies have been thinking to strengthen the
standards to make the Corporate Governance more effective in the context of
the changing corporate environment and contributed their wisdom. The
corporate management is also now feeling the pressure for reforming
accounting practices and level of transparency emanating from alert lenders,
regulatory agencies, financial analyst and above all board of directors who
realize that it is the quality of information which will determine how
efficiently they have discharged their responsibilities towards the good
Corporate Governance.
The Institute of Chartered Accountants of India (ICAI), which is an Apex
Body for the development of accountancy in India, has been working for the
adoption and improvement of accounting standards. In order to frame the
uniform accounting standards the ICAI became an associate member of
International Accounting Standards Committee (IASC) in April, 1974.
Recognizing the need to hormonise the diverse accounting practices prevalent
in India and to integrate them with the global practices, the Accounting
Standards Board (ASB) was constituted in April 1977 by ICAI.
Inview of liberalization of Indian economy in recent times, faster integration
between Indian and International Accounting Standards (IAS) is warranted to
have the benefits of foreign investments. In this direction, ASB of the ICAI
has adopted 15 accounting standards (AS) out of 33 IAS. Two standards i.e.
AS-4 on contingencies and events occurring after the balance sheet date and
AS-5 on prior period and extraordinary items and changes in accounting
policies were made mandatory in April 1989. This was followed by making
six other standards namely AS-1 and AS-7 to AS-11 as mandatory in respect
of accounts for periods beginning on or after 1-4-1991. Due to recent
developments in the economy AS-11 was revised and the revised standard was
issued in December 1994 and became effective since April 1, 1995. The other
standards i.e. AS-12 to AS-15 issued recently are mandatory for the periods
beginning on or after April 1, 1995. Thus, of the 15 standards, at present all
are mandatory except AS-2 Valuation of Inventories and AS-3 Changes in
Financial Position (6).
5
The Table-1 gives an idea about the Indian Accounting Standards that are
matched to the International Accounting Standards.
//TABLE-1//
In order to have an idea about the Indian accounting standards, a brief
description of accounting standards is presented here:
AS-1 relates to the disclosure of accounting policies, which form the basis for
the preparation of financial statements of an enterprise. Some of the
significant policies concerning depreciation, valuation of inventories, fixed
assets, goodwill etc. are needed to be disclosed and should form the integral
part of financial statement. Any change in accounting policy and the extent to
which the change materially affects any item either at present or in future also
require to be stated clearly. The material or total effect is to be quantified to
the extent ascertainable. The amount of the effect of change, which cannot be
ascertained, must also be indicated in financial statements. It also defines the
fundamental accounting assumptions, namely going concern, consistency and
accrual. Any departure from these fundamental accounting assumptions are to
be stated explicitly in financial reporting. The spirit behind AS-1 clearly
demonstrates that even while using other accounting standards, the relevant
accounting policies are to be stated. This standard clearly promotes the good
Corporate Governance, as the standard is one of the important requisites of the
Corporate Governance.
AS-2 concerning valuation of inventories, states that the inventory should
normally be valued at lower of historical cost and net realisable value, where
the cost has to be determined by using FIFO, Average, LIFO, Specific cost or
Standard cost method. This standard minimizes the usage of various methods
of valuation and restricts the company from manipulating the statements to its
advantage.
According to AS-3, the statement of changes in financial position should also
be published along with the annual accounts, with a view to facilitate the users
for an easy understanding and to form the basis for decision making.
6
AS–4 defines contingencies and events occurring after the balance sheet date
and also provides treatment of contingent losses or gains and events. It
suggests to make a reasonable estimate of the resulting loss and disclose in the
statements, where as the gain from the contracts to the extent they are not
executed should not be recognized as such gain may not be realized at all. In
the case of events after the balance sheet date, it states that they are to be
disclosed, if they cause unusual change affecting the existence or substratum
of a business.
According to AS–5, the amounts and nature of the prior period items should
be separately disclosed in the current statement of profit and loss, which
facilitates in assessing the impact of such items on current profit or loss to
make a rational decision.
AS-6 recognizes both the straight line and the written down value methods of
depreciation and specifies that the depreciation method selected must be
applied consistently from period to period.
AS-7 suggests percentage of completion or completed method for the
allocation of revenues or costs for construction contracts and any change in
the method should be disclosed.
AS-8 is concerned with accounting for research and development, which
states that the costs should be charged as expense of the period, in which they
are incurred and if they are deferred, they are to be allocated on a systematic
method.
A-9 states that the revenue should be recognized, provided that at the time of
performance it is not unreasonable to expect ultimate collective.
AS-10 states that the gross book value of a fixed asset should be either
historical cost or a revaluation value and suggests capitalization of borrowing
costs relating to acquisition/construction of fixed assets till they are ready for
use.
7
AS-11 states that the transaction in foreign currency should be ascertained at
the exchange rate existing at the time of the transaction or a standard rate and
gain or loss resulted should be disclosed in the profit and loss account.
AS-12 reveals that the government grants should not be recognized until there
is reasonable assurance that the enterprise will comply with the conditions
attached to them and the grants will be received.
AS-13 defines investment as an asset held by an enterprise for earning income
by way of dividends, interest and rentals, for capital appreciation, or for other
benefits to the investing enterprise.
AS-14 relates to the accounting for amalgamations and AS-15 makes a
distinction between small employer and others and states that there should be
a separate disclosure of the amount of retirement
Though these standards are devised after giving due consideration to local
conditions, recent developments in modern business and international
standards as well, some of them are not free from criticism due to certain
inherent weaknesses. The practices of these standards in the Indian industries
and the gaps are discussed in what follows with a view to strengthen them for
ensuring the good Corporate Governance.
PRACTICES OF ACCOUNTING STANDARDS IN INDIA:
The primary and secondary data collected from the sample companies are
presented in table-2 to table-9 and a careful examination of the tables, made to
find the extent of compliance with the accounting standards and issues in
corporate practices, reveal the following:
//Table-2// to //Table-9//
i). Table-2 reveals that except one sample of private companies which has not
disclosed its opinion, all others (97.5% of the sample) have expressed the
accounting standards as more relevant for Corporate Governance.
8
ii). The table-3 shows that the majority of the sample companies (65%)
disclosed five to ten policies and 22.5% of the sample companies have
disclosed more than ten standards, the remaining have disclosed less than 5
standards. 87.5% of the sample public limited companies have complied with
five to ten accounting standards.
iii). The most of the companies have adopted FIFO and LIFO methods for the
inventory valuation. The FIFO is popular among public limited companies.
The significant aspect is that all the sample companies have followed one or
the other method, but followed different methods.
iv). Except three companies, all other companies have presented either cash
flow or funds flow statement. The majority of the companies have presented
the funds flow statement in their annual reports and some companies have
presented both the funds flow and cash flow statements.
v). Table-6 reveals that the majority of the sample companies (67.5%) have
followed diminishing value method for the computation of depreciation and
10% of the sample have not disclosed the practice, where as, the remaining
followed straight line method.
vi). The sample consists of five construction companies, out of which three
have followed per cent of completion method and the remaining followed
completed method.
vii). About 85% of sample companies have disclosed the expenditure on
research and development, of which 55% followed differed method and 30%
adopted wholesome method as the accounting treatment. The remaining 15%
of the sample companies have not disclosed the practice.
viii). Table-9 reveals that the accounting practices related to amalgamation,
government grants, changes in foreign exchange rates were disclosed by very
few companies as the companies are not concerned with such activities.
9
ISSUES:
i). AS-1 is followed by all most of all the sample companies, since it is
mandatory. The items stated under accounting policies or notes are more or
less same in all the concerns selected for the study but the treatment of some
items were not similar to the other concerns.
The requirement of AS-1 is only to disclose the material facts, what is the
material or immaterial it would be decided by the organization, where the
influence of personal judgement is expected in the absence of concrete
guidelines. Therefore, the existence of AS-1 is doubtful.
ii). In few accounting standards, such as, valuation of inventories and
depreciation accounting, the alternative accounting treatment is allowed. This
kind of flexibility creates problems in judging the quality and reliability of
financial statements of an enterprise and the different methods are followed
for different companies or for different periods, the possibility of inter-unit,
intra-industry or inter-period comparison is impaired. The lack of
comparability renders the financial information less useful and creates
confusion in the minds of the investing public.
iii). Some of the accounting standards are more in the nature of disclosure
than accounting requirements. For example, AS-5 requires a separate
disclosure of prior period items and it does not provide the mechanism to
estimate the impact of prior period items on current year’s operation.
iv). In case of construction contracts, AS-7 provides for adoption of either
completed contract method or percentage of completion method for
recognition of profit on completed contract, which attracts the same limitation
of comparability.
v). The hybrid method of accounting i.e. accounting for income on cash basis
and expenditure on accrual (mercantile basis), followed by corporates,
conveniently allows them to manipulate their reports.
10
vi). The all IAS are not adopted by IASB for India. Just 15 standards adopted
out of 33 IAS, left the various fields as un covered.
vii). The standards setting process is closed and narrow and the execution is
unsound, that causes the various practices and imperfect disclosure, which
defeats the prime objective of accounting standards in achieving the good
Corporate Governance.
The following suggestion are made on the basis of discussions with the
corporates to solve the above issues and to improve the utility of accounting
standards for ensuring the good Corporate Governance.
SUGGESTIONS:
i). The most important suggestion for improving the situation is the wide
acceptance of accounting standards in practice. Though 13 out of 15
accounting standards have been made mandatory by ASB in India, due to the
absence of statutory obligations, only few of business enterprises use these
standards in the preparation and presentation of financial statements. Hence,
the use of accounting standards should become compulsory by framing
appropriate legislations.
ii). The ASB in consultation with other professionals and regulatory bodies
should evolve some mechanism to limit the scope of alternative methods
available within an accounting standard. Thus,the use of uniform accounting
standards would enhance the qualitative and comparability dimensions of
financial statement and reporting.
iii). The establishment of harmony among the applicable laws like Companies
Act, Income Tax Act, Banking Regulations etc., which have significant
bearing on different items of financial statements, would give true and fair
view of business.
iv). The formulation of standards, particularly in the areas in which it does not
exist to day like accounting for leases, segment accounting, accounting for
joint ventures, earning per share, investment in subsidiaries, associates etc.
11
useful to make accounting standards more user friendly and international
acceptable.
With the policy of liberalization and increase in international capital market
activities due to globalization, the gaps between Indian and International
Accounting Standards should be narrowed down, the variety of approaches in
the each accounting standard are to be limited and all accounting standards
have to be made mandatory, otherwise it will be exceedingly difficult for
Indian investors to trust the Corporate Governance.
REFERENCES:
1. Tiwary, Ojha, Arun Kumar, “Corporate Governance in India: What it Means and What
it needs?”, The Indian Journal of Commerce, New Delhi, Oct-Dec,1998, p.154.
2. Chandratre, KR, “Role of Board of Directors in Emerging Dimensions of Corporate
Governance and Impending Changes in Company Law, The Chartered Secretary, The
Institute of Chartered Secretary of India, New Delhi, May 97, p. 505.
3. R.I.Ticker, “Corporate Responsibility, Institutional Governance and the Roles of
Accounting Standards” in Michael Bromwich and Anthony G. Hopwood (Eds.),
Accounting Standards Setting, An International Perspective, Pitman Books Ltd., London,
1883, p.27., Cited in Lele RK, Jawahar Lal, “Accounting Theory”, Himalaya Publishing
House, New Delhi, 96,p.56.
4. The Report of the Cadbury Committee on “Financial Aspects of Corporate
Governance”, The Company Secretary, The Institute of Chartered Secretary of India,
New Delhi, May 97, p. 573.
5. Sir Adrian Cadbury, “Developments in Corporate Governance”, The Company
Secretary, The Institute of Chartered Secretary of India, New Delhi, May 97, p. 497.
6. Verma, Garg, Singh, “Disclosure of Accounting Standards Vis-à-vis Company
Characteristics: A Study of Indian Corporate Sector”, The Indian Journal of Commerce,
New Delhi, Oct-Dec,1998, p.131.
12
TABLES:
Table-1
Comparative Statement of Indian and International Accounting Standards
---------------------------------------------------------------------------------------------------------------------
Indian Accounting Standards International Accounting Standards
---------------------------------------------------------------------------------------------------------------------
AS- 1.Disclosure of Accounting Policies IAS- 1.Disclosure of Accounting Policies
AS- 2.Valuation of Inventories IAS- 2.Inventories
AS- 3.Changes in Financial Position IAS- 7.Cash Flow Statement
AS- 4.Contingencies & Events Occurring IAS-10.Contingencies & Events Occurring
After the Balance sheet Date After the Balance sheet Date
AS- 5.Prior Period & Extraordinary Items IAS- 8.Net Profit & Loss for the Period
and Changes in Accounting Policies Fundamental Errors & Changes in
Accounting Policies
AS- 6.Depreciation Accounting IAS- 4.Depreciation Accounting
AS- 7.Accounting for Construction Contracts IAS-11.Construction Contracts
AS- 8.Accounting for Research & IAS- 9.Research & Development
Development Costs
AS- 9.Revenue Recognition IAS-18.Revenue
AS-10.Accounting for Fixed Assets IAS-18.Property, Plant & Equipment
AS-11.Accounting for Effect of Changes in IAS-21.The Effect of Changes in
Foreign Exchange Rates Foreign Exchange Rates
AS-12.Accounting for Govt. Grants IAS-20.Accounting for Govt. Grants &
Disclosure of Govt.Assistance
AS-13.Accounting for Investments IAS-20.Accounting for Investments
AS-14.Accounting for Amalgamation IAS-22.Business Combinations
AS-15.Accounting for Retirement Benefits IAS-19.Retirement Benefit Costs
in the financial Statements of Employers
-------------------------------------------------------------------------------------------------------------------
Source: Sarada N.P. “Indian and International Accounting Standards”, The Chartered
Accountant, Vol.XLV.No.12,New Delhi, June1996, pp. 13-14.
13
Table-2
Corporate Perceptions on the relevance of Accounting Standards
for Corporate Governance (n=40) ( % )
--------------------------------------------------------------------------------------------------------------------
Accounting Standards Private Sector Public Sector Total
-------------------------------------------------------------------------------------------------------------------
Relevant 23 (95.8) 16 (100) 39 (97.5)
Irrelevant 0 0 0
No Comment 1 (4.2) 0 1 (2.5)
------------------------------------------------------------------------------------------------------------------
Total 24 (100) 16 (100) 40 (100)_
------------------------------------------------------------------------------------------------------------------
Table-3
Corporate Practices of Accounting Policies Disclosed in Annual Reports (n=40) (%)
---------------------------------------------------------------------------------------------------------------------------
Range of Policies Private Sector Public Sector Total
---------------------------------------------------------------------------------------------------------------------------
00 - 05 5 (20.8) 0 5 (12.5)
05 - 10 12 (50.0) 14 (87.5) 26 (65.0)
10 – 15 7 (29.2) 2 (12.5) 9 (22.5)
------------------------------------------------------------------------------------------------------------------
Total 24 (100) 16 (100) 40 (100)_
------------------------------------------------------------------------------------------------------------------
14
Table-4
Corporate Practices of Inventory Valuation (n=40) (%)
---------------------------------------------------------------------------------------------------------------------------
Method Private Sector Public Sector Total
---------------------------------------------------------------------------------------------------------------------------
Average 3 (12.5) 0 3 (7.5)
LIFO 9 (37.5) 4 (25.00) 13 (32.5)
FIFO 6 (25.0) 10 (62.50) 16 (40.0)
Specific Price 1 ( 4.2) 1 (6.25) 2 ( 5.0)
Standard Price 5 (20.8) 1 (6.25) 6 (15.0)
Not disclosed 0 0 0
------------------------------------------------------------------------------------------------------------------
Total 24 16 40 (100)_
------------------------------------------------------------------------------------------------------------------
Table-5
Corporate Practices of Preperation of Statement of Changes in Financial Position (n=40) (%)
-------------------------------------------------------------------------------------------------------------------------
Statement Published PVT. Sector Public Sector Total
------------------------------------------------------------------------------------------------------------------------
Funds Flow 10 (41.66) 8 (50.00) 18 (45.0)
Cash Flow 4 (16.67) 3 (18.75) 7 (17.5)
Both Funds & Cash Flow 7 (29.17) 5 (31.25) 12 (30.0)
Neither Funds Flow nor Cash Flow 3 (12.50) 0 3 ( 7.5)
-----------------------------------------------------------------------------------------------------------------------
Total 24 (100) 16 (100) 40 (100)
-----------------------------------------------------------------------------------------------------------------------
15
Table-6
Corporate Practices of Depreciation (n=40) (%)
--------------------------------------------------------------------------------------------------------------------
Method PVT. Sector Public Sector Total
-------------------------------------------------------------------------------------------------------------------
Diminishing Value 17 (70.8) 10 (62.5) 27 (67.5)
Straight Line 5 (20.8) 4 (25.0) 9 (22.5)
Not disclosed 2 ( 8.4) 2 ( 12.5) 4 (10.0)
------------------------------------------------------------------------------------------------------------------
Total 24 (100) 16 (100) 40 (100)
------------------------------------------------------------------------------------------------------------------
Table-7
Corporate Practices of Construction Contracts (n=5) (%)
--------------------------------------------------------------------------------------------------------------------
Method PVT. Sector Public Sector Total
-------------------------------------------------------------------------------------------------------------------
% of Completion 3 (60) 0 3 (60.0)
Completed 2 (40) 0 2 (40.0)
Other 0 0 0
Not disclosed 0 0 0
------------------------------------------------------------------------------------------------------------------
Total 5 (100) 0 5 (100)
------------------------------------------------------------------------------------------------------------------
16
Table-8
Corporate Practices of Research & Development (n=40)
---------------------------------------------------------------------------------------------------------------------
Method PVT. Sector Public Sector Total
-------------------------------------------------------------------------------------------------------------------
Deferred 10 (41.7) 12 (75) 22 (55.0)
Wholesome 8 (33.3) 4 (25) 12 (30.0)
Not disclosed 6 (25.0) 0 6 (15.0)
----------------------------------------------------------------------------------------------------------------
Total 24 ( 100) 16 (100) 40 (100)
---------------------------------------------------------------------------------------------------------------
Table-9
Corporate Practices of other Standards (n=40)
---------------------------------------------------------------------------------------------------------------
AS.No. Standard No. of companies %
---------------------------------------------------------------------------------------------------------------
4. Contingencies & Events 30 75.00
Occuring after B/S Date
5. Prior Period & Extraordinary Items &
Changes in Accounting Policies 14 35.00
9. Revenue Recognition 37 92.50
10. Fixed Assets 38 95.00
11. Changes in Foreign Exchange Rate 16 40.00
12. Government Grants 10 25.00
13. Investments 30 75.00
14. Amalgamation 4 10.00
15. Retirement Benefits 34 85.00
17
-----------------------------------------------------------------------------------------------------------------
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