Accounting for financial crisis

Most companies are currently faced with specific challenges, questions and concerns that are caused by today's uncertain economic environment. Decisions made several months ago are now being reconsidered and old certainties questioned. Hemant Joshi, Partner, Deloitte Haskins and Sells, discusses the challenges that downturns create for businesses, including the accounting issues that arise, with his colleague, N. Venkatram , Partner, Deloitte Haskins and Sells.

Does the current global financial crisis influence accounting norms and practices that companies need to consider?

It is true that while the current financial crisis is not an accounting crisis, it does generate a range of accounting issues that companies need to consider as they prepare their periodic results and reports.

Contrary to the general perception, it is not just the financial services sector that is affected in such times. Non-financial entities across sectors are affected by declining values of their investments, impairment of assets, difficulties in securing finance, increased cost of borrowing, increased credit risk and currency fluctuations.

In times of market instability, there is an increased potential for management fraud as unexpected losses and financing difficulties create pressure on those who are concerned about the financial performance and solvency of the business.

Has the issue of currency fluctuation got undue importance in the accounting circles?

During the last few months, the rupee has depreciated significantly against the dollar. This weakening of the rupee has a far reaching impact on the economy of the country like India, which depends extensively on the import of oil and other raw materials, affecting the profitability and margins in almost all sectors.

Take the example of power companies, which depend on imported coal for electricity generation.

A rupee depreciation coupled with an inflexible tariff structure could result in some of these power companies being saddled with unforeseen losses. The depreciation of the rupee has resulted in large foreign exchange fluctuation for companies that have taken foreign debt to fund their capital projects.

This has perhaps prompted the Indian accounting standard setters to extend the period up to which corporates have an option to capitalise exchange differences on long-term monetary items incurred for acquisition of depreciable capital assets and to amortise exchange differences on other long-term monetary items over the period of the loans. This dispensation does offer respite in easing volatility in the reported quarterly results, and has been adopted by most large companies.

So this means that impairment of assets assumes great importance in the Indian context?

Yes, more so in the case of Indian companies which have overseas operations. As several foreign economies experience recessionary conditions, impairment of goodwill and many other tangible and intangible assets in companies across geographies will become more widespread. The accounting standards require companies to periodically assess whether there is any indication that the carrying amount of assets recorded in their books may be impaired.

Asset impairment is triggered when the carrying amount of the asset exceeds its recoverable amount, which is typically the net present value of future cash flows generated by the asset or group of assets. Particularly at a time of falling markets, it is critical for companies to reassess the recoverability of goodwill recorded on the balance sheet.

Careful considerations of cash flow projections, growth rates and discount rates used in present value calculations will be critical in evaluating the future of the business.

The future of the business has become more important to accountants?

Yes, there is a significant emphasis on future cash flows in the areas of impairment and going concern. The factors to be considered in respect of performing an impairment review are also relevant in an entity's assessment of going concern. The going concern assumption, which considers the future outlook for the company, is being discussed more rigorously at the company level.

During an economic downturn when there usually is a continued pressure on cash flows, the credit and liquidity risks are likely to be material for many more entities than before. Both solvency and liquidity risks are important considerations in understanding the future viability of the entity.