A practical piece of financial governance advice can be found in Verse 461 of the Tamil Classic Tirukkural “Before undertaking a project, ponder what will be gained, lost and ultimately achieved”.

In hindsight, Vodafone must be ruing the fact that this piece of advice was not given to it when it undertook the project of entering India. Its desire to grow inorganically in India through a marquee acquisition of Hutchinson Telecom has resulted in a litigious tax case in which it appears to have lost half the battle.

Its entry into India was through a joint venture with Essar and a clause in the joint venture agreement has resulted in a valuation dispute. Just so as to rub further salt into the wounds, the entire kerfuffle over the 2G spectrum has resulted in a possibility that it may have to shell out an additional $1 billion as spectrum fees.

The present battle over valuation reignites past fires. In 2008, Essar ventured to sell its stake to another company which was prevented through an arbitration order.

Options for Essar

As per the joint venture Essar has two put options viz. underwritten put option and fair market value put option, for divesting its stake to Vodafone. The joint venture had a clause which gave Essar an option to either sell their entire stake for $5 billion (underwritten put option) or a smaller stake at market value( fair market put option) which has caused the present dispute.

Essar plans to put just over 10 per cent of its share with India Securities Ltd (ISL), a listed company that it controls. Vodafone has objected to Essar's plan to part-list its stake as it fears the move would give an inflated valuation of its venture as ISL is a highly illiquid vehicle and post-merger, more than 95 per cent of the shares will be under the control of the Essar Group and two other shareholders. Accordingly, small amounts of buying or selling could distort ISL's share price. It appears that temporary peace has been bought by both the warring parties appointing an independent valuer each. Global accounting norms are uniform in their stand that the quoted market price in an active market is the best indicator of the much-ridiculed Fair Value (FV). Vodafone is of the opinion that an active market does not exist for ISL shares or the market is too closely-held to be called active. Hence, the residuary option under accounting standards to opt for independent valuers.

Get real

The spat brings us back to the much-argued introduction of International Financial Reporting Standards (IFRS) into India and its focus on valuation. A recent report by two professors to the Institute of Chartered Accountants of India (ICAI) highlights the fact that the socio-economic factors of moving over the IFRS can be distortionary, to which everyone appears to have turned a blind eye. The report rakes up the utility of IFRS as a concept and FV as a Valuation measure.

At first blush, the report seems to have come a bit too late — regulators thought about IFRS in 2009 and initiated action in 2010 while the report comes months later.

Regulators apart from the Ministry of Corporate Affairs (MCA) have been soft-pedalling on IFRS which has resulted in the present pause. Proponents of FV argue that it is time to get real regarding values put on the financial statements of companies which is the USP of FV — you cannot manage what you cannot measure realistically.

It has been universally accepted that FV is not as clean as snow which has prompted the International Accounting Standards Board (IASB) to think of calibration models for FV.

Proponents of FV flash the Balance-Sheet of Lehman Brothers in support of their cause — the financial crater that the company sunk into could have been noticed much earlier, and probably rectified, had they accounted and not merely disclosed collaterised debt obligations using FV. Having implemented the standard on impairment of assets and mandated the standards on financial instruments from April 2011 — which are similar to their namesakes issued by the IASB - we have accepted FV for a significant portion of our financial statements.

Branding IFRS as a magic wand that will increase capital flows to India and access to cheaper funds may not necessarily be true, but the values that appear in IFRS financial statements could be close to reality. If they are volatile, they reflect current market conditions. As Vodafone-Essar proves, financial instruments can be complicated and should be valued appropriately which is the intention of all standards on financial instruments. Having opted for a carve-out approach, we can delay IFRS, but should not allow it to decay.

(The author is a Bangalore-based chartered accountant.)

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