Accounting standards for banks need review

ACCOUNTING STANDARDS have come in for a great deal of contention in the reports submitted by statutory auditors for commercial banks. With such qualifications a rarity in the audit reports relating to other business enterprises, there is a feeling among the lay public that banking is a sector where established standards of accounting are least adhered to. The scams which keep popping up with a sickening regularity have not helped things either. Here we will examine the relevance of qualifications in the audit reports vis-a-vis accounting standards.

The accounting standards which have come in for contention are:

Coming to AS-9, the major aspects which are of relevance to commercial banks are: 1. Accounting for their main source of income namely interest — the standard states that it should be recognised on a time proportion basis; 2. In the case of other receipts, the focus should be whether the service has been provided, `once for all' or `on a continuing basis' and the standard goes on to state that if at the time of raising any claim it is unreasonable to expect ultimate collection, revenue recognition should be postponed.

It is essentially in the case of interest being reckoned on cash basis on non-performing assets that the audit fraternity is yet to come to terms on whether such accounting is in conformity with AS-9 or not. In spite of the Institute of Chartered Accountants of India (ICAI) assuring the members that it would indeed be so, the qualification in the audit report on that count has not abated.

As far as commission income on guarantees and letters of credit, a finality as to whether the service rendered in those cases are `one time' or `continuing' is yet to be reached. Also the underlying philosophy of accounting standards that they are intended to be applied only to items which are material has not had all that glitter, which is reflected in items such as locker rent, property tax, telephone bills, and electricity dues being held under a microscope. The latest to be added to this list is the `insurance claim' which is said to fall under the accrual concept.

The conflict underlying AS-11 is essentially due to two factors: (a) As per Federation of Exchange Dealers Association of India (FEDAI) guidelines, outstanding foreign exchange contracts have to be revalued on balance sheet date as per their rates and resultant profit or loss is to be reflected in the profit and loss account and (b) As per Reserve Bank of India guidelines, banks which have branches overseas, should translate the figures on the balance sheet date at the closing rate and the difference, if credit should not be taken credit for and loss, if any, should be absorbed in the accounts during the year.

As against these methods, AS-11 prescribes the translation difference in the case of outstanding forward exchange contracts to be recognised as income or expense as the case may be over the life of the contract and in the case of translation of overseas branches, the resultant difference is to be recognised in the profit and loss account for the year.

There are, of course, other minor differences between AS-11 and those prescribed for banks such as rates to be adopted for translation of certain accounts (EEFC/RFC/FENR) and in the case of foreign branch, the rate to be adopted for translating fixed and non-monetary assets.

One would notice that the prescription of AS-11 is conservative when compared to FEDAI guidelines and RBI guidelines sound conservative when it comes to treatment of translating the financials of overseas branches. Banks being bound by the regulator have adopted what has been prescribed to them.

Under AS-15, the bone of contention has been the treatment of leave encashment benefits. Most of the banks have proceeded on a logic which has not found favour with the ICAI. The standard requires the liability on this count to be accounted on an accrual basis arrived at actuarily while banks have opted for `pay as you go' method. The ICAI sought to telescope AS-5 as well while dealing with accounting for leave encashment benefits of retirees, asking the professionals to highlight the prior period quantum.As far as depreciation accounting is concerned, the relevant accounting standard requires the depreciation for the year for each class of asset to be disclosed.

The present format prescribed under Schedule III of the Banking Regulations Act provides for disclosure of depreciation for the year for all assets in entirety. To that extent there lies a deviation which has been called to question in the balance sheets of a few private sector banks.

In addition, during 2000-01, the RBI directed that banks depreciate computers added during the year over a three year period and also wanted to write off the balance which existed as of March 31, 2000 under the head Computers over the next three years. In the process, the life of the asset got restated in different ways and consistency, a virtue prescribed under AS-6, got derailed.

A fundamental accounting concept called `prudence' came in for close scrutiny in the case of some banks. As per the present method of valuation of investments prescribed for banks, investments held under `held for trading' get restated periodically based on the market rates and as an offshoot, the resultant appreciation/depreciation gets recognised.

Some auditors have felt that such an accounting treatment is in negation of `prudence' and have questioned the wisdom of taking credit for such notional appreciation. Interestingly, in one particular case where the management did not reckon the appreciation, choosing to be ultra conservative, the auditors chose to qualify their report on the score that the RBI directive has not been followed.

One would, by this time, be aware that in all the above cases, banks had no option but to follow the regulator's directive. Under the circumstances, the question arises whether the professionals are right in qualifying their reports on the grounds of non-adherence to accounting standards.

Again, the necessity of any standard is to bring about uniformity among all players of a particular industry. As long as that is achieved through a regulator's directive, should ICAI insist on having it say, one wonders?

The ICAI itself states that local customs, usage, and regulations would take a precedence over its standards but yet is unwilling to give such a tag to RBI's directives. This would be clear if one peruses ICAI's exhortation of its members on the treatment to be extended for translation of the figures of overseas branches. Till it comes out with a set of standards applicable exclusively for the banking industry, the ICAI can identify such of those standards from which the banking industry can be exempt as it did with the accounting standards concerning investments.

The professionals on their part have also got to display their independence keeping the concept of materiality in mind before plunging into `qualify' their report. These are days of summit talks and perhaps one between the regulator and the ICAI should clear the air.

P. S. V. Chari & P. S. Narasimhan

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