One Accounting Language

One Accounting Language

Posted by Dr.M.Jayasree, Assistant.Professor,HBS,GITAM University

For quite a long time corporates were comfortable using local standards for reporting financial statements. This went well till commercial operations were within the borders. But ever since the WTO (World Trade Organization) came into existence, businesses are no longer confined to borders. The globe has now witnessed a sea change and corporates are now extending their business beyond borders. The huge capital requirements are making corporates to depend on foreign capital for investment purposes. This made them to report their financial statement in the standards of country from where they raise capital. This involves costs as the corporates have to prepare financial statements both in local GAAP (Generally Accepted Accounting Principles) and also as per the standards of the country from where capital was raised. The next challenge was that profitability and financial position both would be different under both the standards, creating confusion in the minds of the investor. Further global comparison of firms was not possible and acquisitions overseas were a real challenge. This made accounting experts to think a way out to have a uniform standard that can be followed across the globe. The answer to this was International Financial Reporting Standards (IFRS).

India did make an attempt to converge its IGAAP (Indian Generally Accepted Accounting Principles) with IFRS, but there were issues coming up in the convergence. Though the mandate convergence is delayed there are few corporates which are adhering to IFRS and that’s a welcoming move. A few observations of the financial statements of corporates following both IGAAP and IFRS surfaced certain issues. Firstly there were reporting IGAAP in rupees and IFRS in dollars. Secondly, detailed notes for IFRS were not available. The grouping of transaction was also different under both the standards. Therefore understanding financial statement became more complex for individuals and investors.

One way of coming to some common understanding, would be to use the Du-Pont Pyramid (See Exhibit I & II). The Du-Pont analysis of a firm’s performance is based on three parameters namely, operating Efficiency, Asset Efficiency and Equity Multiplier. This would give us better understanding of the financial statements.  The operating efficiency would be measured by net profit margin; asset efficiency would be measured by total asset turnover and equity multiplier by financial leverage. The end of Du-Pont would be the return on equity. Ultimately, every investor looks for return on equity. The use of Du-Pont to some extent would bring understanding of the financial statements and would ease the job of financial analyst.

The author can be reached at sreemj@gitam.in

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