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PRESIDENT

G. N. Venkataraman
email : president@icwai.org
VICE PRESIDENT
B. M. Sharma
email : vicepresident@icwai.org
CENTRAL COUNCIL MEMBERS
Chandra Wadhwa, V. C. Kothari,
A. N. Raman, S. R. Bhargave,
Somnath Mukherjee, Hari Krishan Goel,
Dr. Sanjiban Bandyopadhyaya,
M. Gopalakrishnan, Suresh Chandra
Mohanty, Ashwin G. Dalwadi,
Balwinder Singh, A. S. Durga Prasad
GOVERNMENT NOMINEES
S. C. Vasudeva, R. K. Jain,
P. K. Sharma, Jaikant Singh,
T. S. Rangan
CHIEF EXECUTIVE OFFICER
Sudhir Galande
ceo@icwai.org.
Senior Director (Examinations)
Chandana Bose
exam.cb@icwai.org.
Senior Director
(Administration & Finance)
R N Pal
fna.rnpal@icwai.org.
Director (Technical)
J. P. Singh
technical.jps@icwai.org.
Director (Studies)
Arnab Chakraborty
studies.arnab@icwai.org.
Director (CAT)
L. Gurumurthy
cat.gurumurthy@icwai.org.
Additional Director (CEP)
D. Chandru
cep.chandru@icwai.org.
Additional Director (Membership) cum
Joint Secretary, Kolkata
Kaushik Banerjee
membership.kb@icwai.org.
Additional Director (International Affairs)
S. C. Gupta
admin.gupta@icwai.org.
EDITOR
Sudhir Galande
Editorial Office & Headquarters
12, Sudder Street, Kolkata-700 016
Phone : (033) 2252-1031/34/35,
Fax : (033) 2252-1602/1492
Website : www.icwai.org.
Delhi Office
ICWAI Bhawan
3, Institutional Area, Lodi Road
New Delhi-110003
Phone : (011) 24622156, 24618645,
24641230, 24641231, 24641232,
24643273, 43583642, 24634084
Fax: (011) 24622156, 24631532,
24618645

The
Management
Accountant
Official Organ of The Institute of Cost and Works Accountants of India

Volume 44 No. 8 August 2009


Editorial

597

Presidents Communique

598

Our New President

600

Our New Vice-President

601

New Committees of ICWAI

602

Cover Features
Financial Engineering: Recent
Instruments in Corporate Finance
by Dr. S. S. Chahal &
Vijay Singh Hooda
604

Z-Score Analysis - A Tool to Predict


Financial Health
by Dr. K. Venkat Janardhan Rao &
M. Durga Prasad
608

Revamping Global Financial


Architecture: an Overview
by Dr. R. K. Raul
611

Requirement of Balancing between


capital structure and assets structureleverages anallysis
by Susanta Kanrar
615

My Experiment with Inventory


Management
by T. Renganathan
620

The New Age Financial Reporting


System-An Overview of Extensible
Business Reporting Language (XBRL)
by Anupam Karmakar &
Abhijit Karmakar
624

Shedding New Light on Standard Cost


Variances: Incorporating Environmental
Considerations into Product Mix
Decisions
by Ramamohana Rao
Guttikonda
629

the management accountant, August, 2009

Issues in Taxation
Transfer Pricing - A Study
by Debasish Dutt
636
Accounting Issues
IAS 20, Accounting for Government
Grants and Disclosure of Government
Assistance - A Closer Look
by K. S. Muthupandian
645
Issues in Management Accounting
Cost Accountant - Role in IFRS
by Rammohan N Bhave
652
Budget analysis
Budget 2009 : Expenditure of Rs. 10.21
lac crores analysed
by Dr. V. M. Govilkar
653
Legal update
Is UCP 600 solution to Letters of Credit
problems?
by J. K. Budhiraja
655
Institute Notification
660
Book Scan
664
Notice
666
IDEALS
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Accountancy profession q to develop
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equip them for functions q to ensure
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abreast of new developments.
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reviewers in this Journal do not
necessarily reflect the opinion of The
Institute of Cost and Works Accountants
of India nor can the Institute by any
way be held responsible for them. The
contents of this journal are the copyright
of The Institute of Cost and Works
Accountants of India, whose permission
is necessary for reproduction in whole
or in part.

595

The Management Accountant


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MISSION ST
ATEMENT
STA
ICWAI Professionals would
ethically drive enterprises globally by
creating value to stakeholders in the
socio-economic context through
competencies drawn from the
integration of strategy, management
and accounting.

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596

VISION ST
ATEMENT
STA

The views expressed by the


authors are personal and do not
necessarily represent the views
and should not be attributed to
ICWAI.
the management accountant, August, 2009

Editorial
The new age Finance
Finance has recently been in the news for quite some
time for obviously all the wrong reasons. It is today
well known in the financial world that there are just
two elements that drive modern day finance- greed
and fear. However, being in ICWAI, a leading name in
the financial realm; I felt the urge to delve into the
basics of finance which we somewhere down the line
have lost touch of, to introspect and attempt to crystal
gaze into its future.
In an age where the scope of finance is very complex
and overreaching, I started with understanding what
does finance basically constitute. Many definitions
abound but the one that I found to be the most
appropriate was: It is the science of management of
money and other assets. Next step was to chart its
course from its simple avatar to its present state. The
bygone era saw the presence of a vertically integrated
intermediary (e.g a bank), which conducted business
in an ad hoc (read less routinised) manner and with
rigid expenses. Client relationship formed the basis of
the transactions from the origination of the transaction
till its repayment. Finance as a subject itself was a
subset of economics, occupying a relatively narrow
area in public sphere.
It is a known fact that as an economy grows so does
the share of finance in the GDP pie. The 21st century
altered the financial landscape like never before. The
combination of financial theory and quantitative
techniques has enabled the proliferation of new
financial products as risk management and return
maximizing tools, convergence of information
technology has spawned cross border financial flows
and thereby greater integration of finance. Finance too
found wide and interesting applications ranging from
philanthropy to fighting climate change. All this implied
greater efficiency in allocation of financial resources,
wider access of credit to a cross section of people
and businesses, lower costs and better terms of credit,
more financial options for everyone suited to each ones'
maturity, risk, liquidity, credit, volatility and risk
preferences. This has also increased the spoils of the
game beyond logical proportions. The handsome
returns from the business attracted many players in
the domain, which led to increasing competition. This
relentless market pressure while fostering faster and
more creative financial innovations on one hand, also
led to misalignment of incentives of market participants
the management accountant, August, 2009

on the other hand with virtual disregard to customers'


needs. Soon speculation surpassed genuine demand
supply conditions as drivers of financial prices.
Another consequence was the universalisation of the
financial services- providing all types of financial
services under the same roof. This led to many financial
intermediaries entering the scene and also gave birth
to novel formats of lending and investing. While the
'slice and dice culture' of modern finance did well to
expand breadth, width and volumes of the market, it
destroyed the age-old edifice on which financial
transactions were traditionally carried out. Soon
behavioral finance was replaced by mathematical
models.
The emergence of the financial malls or supermarkets
gave birth to newer risks, which has necessitated
tighter regulation. The regulations were mostly aimed
at ensuring greater transparency, protection of interest
of all stakeholders, upholding ethical standards of
business of the highest level and advocating greater
prudence in financial transactions while providing an
enabling environment for financial development.
However, despite stronger inter and intra national
regulation and supervision, the market participants have
smartly found avenues of profiting from regulatory
arbitrage and non-compliance of regulations. The fact
that the market has always been ahead of regulation
has given rise to a greater risk- the risk of the unknown
risks, which makes preventive regulation more
difficult.
It is widely believed that modern finance has contained
within it the seeds of its own destruction. Therefore,
modern finance needs a new paradigm. That is easier
said than done, of course. But a good start is for
modern finance to abandon its aspiration to become
the "physics of social sciences" and return to its roots
as a social science. Modern finance depends on human
behavior. Behavioral psychology and sociology -- and
not dangerous mathematical models -- are the future
of finance.
It is our duty as Cost Accountants and as significant
players in the financial world to be abreast of whatever
good the area has to offer and to harness the benefits
for the betterment of societal development. The August
issue brings to you such selected updates in the world
of finance. Wishing all fellow Indians a very Happy
Independence Day.
597

l Presidents

Communique l

My dear professional friends,


As I assume office from 22nd July, 2009 as president of the Institute,
with the support of my colleagues in the council, my thoughts go back
to the great efforts and leadership of my predecessors and stalwarts who
have adorned this office with dignity, and built this great Institution. Some
of them are still active, and provide the much needed support, to the
profession. I am fortunate the Institute is in a stage of take off, due to
the great efforts of my immediate predecessors who are still in the
council to provide me with their guidance.
The profession has come to a stage of reckoning in Cost Audit, where all of us are eagerly
awaiting the adoption of the recommendations of the Expert Group by government. We are
not resting with this, as the council is always exploring newer pastures to the profession,
where our expertise can be used for Inclusive growth of the Economy.
In the Employment field, our members have stood out, in the forefront due to the training
and Curriculum prescribed by the Institute in the New Syllabus.
Internationally we have been able to make our profession well recognized by the recent tieups we had with the Institute of Management Accounting USA and similar efforts are in the
offing with the Other International Bodies.
Nationally we are always well recognized to provide the leadership role and service to all
segments of society. In saying this I am aware of the recent decision of the government to
throw open the specialized skills required for determination of value in Central Excise to
the others also, which has fully engaged the attention of the council.
We have brought this anomaly to the notice of the concerned, who have assured us to look
into this.
Well, as you are all aware, the profession requires the support and blessings, of numerous
members and well wishers, apart from the actions of the council, to keep our flag flying. I
appeal to one and all to contribute your fullest support in all forms to march forward and
fulfill the vision of the founding fathers, who have built this great Institution to play a vital
role in improving the Economy and meet the expectation of the common man to lead a life
of comfort, in a competitive Economy.
There is no limit to our contributions as the Society is fast changing and resources are limited
to maximize on usage.
This age is a age of survival of the fittest and we can do our best in this era by making our
society more acceptable, and ready to face the Challenges facing one and all.

598

the management accountant, August, 2009

l Presidents

Communique l

We are a society, who have learnt to be resilient, and face all odds which should help us to
grow, despite the Global Economoic Recession which has had its toll in many facets of the
Economy. There seems to be some cheer, as we get reports of a revival in the US economy
which has thrown many in a quandary. Let us show the world we are more flexible if not
insulated. The profession can play a vital part in this process.
The one aspect that is of concern to all of us is the apathy of sizable number of members not
renewing their membership, which will have a serious impact when opportunities face us in
the profession. There should be a Voluntary Sense of ownership and pride, to declare oneself
that he continues to be a member of this great Institution, which has given him a pride of
place, as is the case with all the other professions.
The council is seriously devising means, to restore the membership, and also enlist new
members who have completed the requirements, and have not applied for membership due to
one reason or the other.
I would earnestly appeal to all those who have discontinued their membership, and for the
new entrants to register themselves, without delay, and help the Institute to face the new
challenges with combined force. I am sure this message should be passed on to the concerned
to act.
Let us declare the year 2009-10 as a year of Consolidation and Progress.
Regards,

(GN Venkataraman)
President

the management accountant, August, 2009

599

l Our

New President l

ICWAI is happy to announce its new President for the year


2009-10, Shri G.N.Venkataraman. A Commerce graduate from
Mysore University and a law graduate from Bangalore University,
Shri Venkataraman is a Fellow Member of ICWAI. He is an
alumnus of IIM, Ahmedabad and was also an Associate Member
of the British Institute of Management, London.
Shri Venkataraman has served for 14 years in the private sector in
reputed companies like Tatas, TVS and Yenkay. But a major part of his professional
life (26 years) has been spent in various challenging positions in PSUs. He was the
General Manager (Finance & Audit) at Bharat Earth Movers Ltd., Bangalore. At
Mysore Paper Mills Ltd., Bangalore where he retired as Director-Finance, he was
responsible for turning round a Rs.92 crore loss making unit to a Rs.62 crore profit
making one. He has been conducting several training programmes for PSUs and
private sector, both in-house as well as thematic programmes for the last 20 years.
For the last 10 years, Shri Venkataraman has been practicing as a Senior Partner of
M/s GNV Associates, Cost Accountants. Shri Venkataraman is well recognized in
academic circles also. He was Director (Operations) of Sambharam Institute of
Technology and was member on the board of Shri Krishnadevaraya Institute of
Management, Ananthpur. He has presented papers at various prestigious conferences
and seminars right from 1971.
Shri Venkataramans contribution to the field of Cost Accountancy has been immense.
He has occupied various positions as Secretary, Vice Chairman and Chairman of
Bangalore Chapter and Southern India Regional Chapter in the past. Prior to becoming
President of ICWAI, he was Chairman of Continuing Education Programme of
ICWAI. He was the Chairman of the National Cost Convention of ICWAI held for
the first time outside metropolis in Bangalore in 1990-91. He was also the Chairman
of the South East Asian Convention of ICWAI held at Chennai. His work has led
him to be widely traveled around the globe.
We wish Shri G.N.Venkataraman the very best for the present challenge as president
of ICWAI.

600

the management accountant, August, 2009

l Our

New Vice-President l

ICWAI is pleased to announce the appointment of Shri B.M.Sharma as the


new Vice-President of ICWAI for the year 2009-10. An M.Com from
Pune University, Shri Sharma is a Fellow Member of ICWAI and a Central
Council member of the Institute for the periods 2004-07 and 2007-till
date. Shri Sharma is a practicing Cost Accountant with over 19 years of
professional experience.
Shri Sharma has previously held the post of Vice- President of ICWAI in
the year 2005-06. Prior to being elected as Vice- President for the year 2009-10, he was the
Chairman of Professional Development (Technical) Committee of ICWAI in the years
2004-05 and 2008-09. He has been the architect behind publication of various professional
development publications like Guidance Notes on Cenvat Audit, Valuation Audit under Central
Excise Act, VAT- Its Accounting & Auditing, Input Tax Credit in Service Tax, Guidance Note
for Valuation fro CAS-4 under Excise etc. He was also instrumental in bringing out four
Management Accounting guidelines---Implementing Benchmarking, Valuation Management
-A guide to Management Accountant, Implementing Corporate Environmental Strategies and
Tools & Techniques of Environmental Accounting. He has represented ICWAI and India at
various international fora of accountants like South Asia Federation of Accountants (SAFA),
Confederation of Asian and Pacific Accountants (CAPA) etc.
Shri Sharma was president of Tax Bar Association of Pune for the period 1994- 98. He was
also on the Board of Directors of Maharasthra State Warehousing Corporation as nominee of
Central Warehousing Corporation (Central Government) for the period 2205-08. At present,
he is a member of the State Level Taxation Committee of Maratha Chamber of Commerce &
Agriculture, Pune.
Shri Sharma has undertaken many training programmes on VAT organized by NIPFB and
sponsored by Government of Maharasthra. He has been a faculty on VAT for various seminars
organized by Regional Councils of ICWAI, ICSI, branches of ICAI and other professional and
trade bodies. Apart from this, Shri Sharma has also presented papers on VAT, Sales Tax,
Corporate Laws and Effective Vendor Planning for management of Sales Tax/ VAT leading to
cost reduction. Widely traveled, Shri Sharma has participated in many seminars and
conferences as paper writer, moderator, Chairman as well as organizer of such programmes.
We wish Shri B.M. Sharma all the success for his current responsibility as vice- president of
ICWAI.
the management accountant, August, 2009

601

Standing & Other Committees of the Council of ICWAI for 2009-10


A. Executive Committee
1. Shri Venkataraman, G. N., President
2. Shri Sharma, B. M., Vice-President
3. Shri Banerjee, Kunal
4. Shri Wadhwa, Chandra
5. Shri Singh, Balwinder
6. Shri Bhargave, S. R.
7. Shri Mukherjee, Somnath
Shri Sudhir Galande (CEO)
C. Examination Committee
1. Shri Venkataraman, G. N., President
2. Shri Sharma, B.M., Vice President
3. Shri Kothari, V.C.
4. Shri Gopalakrishnan, M.
5. Shri Mohanty, S. C.

Quorum (4)
Chairman
Member
Member
Member
Member
Member
Member
Secretary
Quorum (3)
Chairman
Member
Member
Member
Member

Smt Chandana Bose (Sr. Director-Exam)


Secretary
E. Training & Educational Facilities Committee
Quorum (4)
1. Shri Mukherjee Somnath
Chairman
2. Shri Bhargave, S. R.
Member
3. Dr. Bandyopadhyaya, Sanjiban
Member
4. Shri Mohanty, S. C.
Member
5. Shri Kothari, V. C.
Member
6. Shri Raman, A. N.
Member
7. Shri Wadhwa, Chandra
Member
8. Shri Singh, Balwinder
Member
9. Shri Durga Prasad, A.S.
Member
10. Shri Dalwadi, A. G.
Member
Shri Arnab Chakraborty (Director-Studies)
Secretary
G. Research & Journal Committee
Quorum (4)
1. Shri Kothari, V. C.
Chairman
2. Shri Raman, A. N.
Member
3. Shri Wadhwa, Chandra
Member
4. Shri Bhargave, S. R.
Member
5. Shri Durga Prasad, A.S.
Member
6. Dr. Bandyopadhyaya, Sanjiban
Member
7. Shri Mukherjee, Somnath
Member
8. Shri Singh, Balwinder
Member
Ms. Anamika Mukherjee (Dy Director- R&J)
Secretary
I. Members' Facilities & Services Committee
Quorum (3)
1. Shri Goel, H. K.
Chairman
2. Shri Singh, Balwinder
Member
3. Shri Dalwadi, A G.
Member
4. Shri Gopalakrishnan, M.
Member
5. Shri Mohanty, S. C.
Member
6. Shri Mukherjee, Somnath
Member
7. Dr. Bandyopadhyaya, Sanjiban
Member
Shri Kaushik Banerjee (Additional Director)
Secretary
K. WTO & International Affairs Committee Quorum (4)
1. Shri Raman, A. N.
Chairman
2. Shri Dalwadi, A. G.
Member
3. Shri Kothari, V. C.
Member
4. Shri Gopalakrishnan, M.
Member
5. Shri Banerjee, Kunal
Member
6. Shri Mukherjee, Somnath
Member
7. Shri Jain, R. K.
Member
8. Shri Vasudeva, S. C.
Member
9. Shri Wadhwa, Chandra
Member
10. Shri Goyal, B. B., [Adviser (Cost),
Govt. of India (Co-opted)]
Member
Shri S.C. Gupta, (Additional. Director)
Secretary

B.
1.
2.
3.
4.

Disciplinary Committee
Shri Venkataraman, G. N., President
Shri Banerjee, Kunal
Shri Raman, A. N.
Dr. V. R. S. Sampath
(Nominee of Central Government)
5. Shri V. S. Jagannathan
(Nominee of Central Government)
Shri Kaushik Banerjee (Additional Director)
D. Finance Committee
1. Shri Venkataraman, G. N., President
2. Shri Sharma, B.M. ,Vice President
3. Shri Banerjee, Kunal
4. Shri Goel H.K.
5. Shri Dalwadi, A. G.
6. Dr. Bandyopadhyaya, Sanjiban
7. Shri Durga Prasad, A.S.
Shri R. N. Pal (Sr. Director-A&F)
F. Professional Development Committee
1. Shri Bhargave, S. R.
2. Shri Mohanty, S. C.
3. Shri Gopalakrishnan, M.
4. Shri Kothari, V. C.
5. Shri Mukherjee, Somnath
6. Dr. Bandyopadhyaya, Sanjiban
7. Shri Rangan, T. S.
8. Shri Goyal, B. B. [Adviser (Cost),
Govt. of India (Co-opted)]

Shri. Sudhir Kumar Sharma (Dy. Director- Technical)


H.
1.
2.
3.
4.
5.
6.
7.

Continuing Education Programme Committee


Shri Dalwadi, A. G.
Dr. Bandyopadhyaya, Sanjiban
Shri Durga Prasad, A.S.
Shri Bhargave, S. R.
Shri Goel, H. K.
Shri Mohanty, S. C.
Shri Jain, R. K.

Shri D. Chandru (Additional Director)


J. Regional Council & Chapter Co-ordination Committee
1. Shri Mohanty, S. C.
2. Shri Goel, H. K.
3. Shri Kothari, V. C.
4. Shri Durga Prasad, A.S.

Shri S. R. Saha (Additional Director)


L.
1.
2.
3.
4.
5.
6.
7.

Quorum (3)
Chairman
Member
Member
Member
Member
Secretary
Quorum (4)
Chairman
Member
Member
Member
Member
Member
Member
Secretary
Quorum (5)
Chairman
Member
Member
Member
Member
Member
Member
Member
Secretary
Quorum (4)
Chairman
Member
Member
Member
Member
Member
Member
Secretary
Quorum (3)
Chairman
Member
Member
Member

Secretary

Corporate Laws & Cost Audit Committee Quorum (4)


Shri Banerjee, Kunal
Chairman
Shri Wadhwa, Chandra
Member
Shri Gopalakrishnan, M.
Member
Shri Raman, A. N.
Member
Shri Vasudeva, S. C.
Member
Shri V Kalyanraman, Past President, ICWAI (Co-opted)
Member
Shri J.K.Puri, Past President, ICWAI (Co-opted)
Member

Shri. J.P. Singh, (Director- Technical)

Secretary

President and Vice-President are Permanent Invitees to all the Committees

602

the management accountant, August, 2009

Standing & Other Committees of the Council of ICWAI for 2009-10


M. Cost Audit Assurance Standard Board
1. Shri Gopalakrishnan, M.
2. Shri Dalwadi, A. G.
3. Shri Banerjee, Kunal
4. Shri Mukherjee, Somnath
5. Shri Mohanty, S. C.
6. Shri Singh, Balwinder
7. Shri Bhargve S R
8. Dr. Bandyopadhyaya, Sanjiban
9. Shri Raman, A. N.
10. Shri Goel, H. K.
Shri Sudhir Kumar Sharma, (Dy. Director Technical)
O. ICWAI-ICAI-ICSI Co-ordination Committee
1. Shri Venkataraman, G. N., President
2. Shri Sharma B.M . Vice President
3. Banerjee, Kunal
4. Shri Wadhwa, Chandra
5. Shri Durgaprasad, A S
6. Shri Raman, A. N.
7. Shri Sharma, P. K.
8. Shri Vasudeva, S. C.
9. Shri Singh, Jaikant, Nominee - MCA
Shri Sudhir Galande (CEO)
Q. Taxation, Perspective Planning &
Execution Committee
1. Dr. Bandyopadhyaya, Sanjiban
2. Shri Goel ,H.K.
3. Shri Somnath, Mukherjee
4. Shri Durgaprasad, A.S.
5. Shri Wadhwa, Chandra
6. Shri Mohanty S C
7. Shri Bhargave S R
8. Shri Singh, Balwinder
Shri. Chiranjib Das Asst.. Director (Studies)
S . Cost Accounting Standards Board
1. Shri Wadhwa, Chandra
2. Shri Banerjee Kunal
3. Shri Gopalakrishnan, M.
4. Shri Raman, A. N.
5. Shri Mukherjee, Somnath
6. Shri Dalwadi A G.
7. Shri Vasudeva, S. C.
8. Shri Goyal B. B.
9. Shri Joshi D.V.
10. Dr. Bhattacharyya, Asish K,
11. Dr. Gandhi, Sailesh,
12. Dr. Gupta, C. P.
13. Shri Muraliprasad, S. A.
14. Shri Singh, Jaikant,
15. Shri Maheshwari, Sanjeev
16. Shri Kasodkar, Milind
17. Shri Adukia, Raj Kumar,
18. Shri Vig, Vikas,
19. Shri Thiagarajan, J.
20. Nominee of FICCI
21. Nominee of SEBI
22. Shri Sahay, R.N.
23. Shri. Dhingra, A. K
Shri J. P. Singh (Director-Technical)

Quorum (4)
Chairman
Member
Member
Member
Member
Member
Member
Member
Member
Member
Secretary
Quorum (4)
Chairman
Member
Member
Member
Member
Member
Member
Member
Member
Secretary
Quorum (4)
Chairman
Member
Member
Member
Member
Member
Member
Member
Secretary

Committee for Accounting Technicians


Shri Singh, Balwinder
Shri Kothari, V. C.
Shri Dalwadi, A. G
Shri Goel, H. K.
Shri Mohanty S C
Shri Jain, R. K.
Shri Sharma, P. K.

Quorum (4)
Chairman
Member
Member
Member
Member
Member
Member

Shri L. Gurumurthy ( Director-CAT)


P. Centre of Excellence & Infrastructure Committee
1. Shri Sharma B.M., Vice President
2. Shri Kothari, V. C.
3. Shri Durgaprasad, A S.
4. Shri Goel ,H.K.
5. Shri S Mohanty, S. C.

Secretary
Quorum (3)
Chairman
Member
Member
Member
Member

N.
1.
2.
3.
4.
5.
6.
7.

Shri Tarun Kumar (Dy. Director)


R. Committee for Banking, Capital
Markets & Information Technology.
1. Shri Durgaprasad, A.S.
2. Shri Wadhwa, Chandra
3. Shri Banerjee, Kunal
4. Shri Raman, A. N
5. Shri Bhargave , S. R
6. Dr. Bandyopadhyaya, Sanjiban
7. Shri Sharma, P K
Shri Sudhir Galande (CEO)
Mrs Anita Singh Jt. Director (IT)

(Central Council Member -ICWAI)


(Central Council Member - ICWAI)
(Central Council Member - ICWAI)
(Central Council Member - ICWAI)
(Central Council Member - ICWAI)
(Central Council Member - ICWAI)
(Government Nominee - ICWAI)
[Adviser (Cost), Govt. of India]
(Past President ,ICWAI)
(Professor - IIM, Calcutta)
(Professor - IIM, Ahmedabad)
(Professor MDI, Gurgaon)
(Director, SAM Consultancy Services)
(Nominee of MCA)
(Nominee of ICAI)
(Nominee of ICSI)
(Nominee of ASSOCHAM)
(Nominee of PHDCCI)
(Nominee of CII)
(Nominee of CCI)
(Nominee of TRAI)

Secretary
Quorum (4)
Chairman
Member
Member
Member
Member
Member
Member
Secretary
Secretary
Quorum (8)
Chairman
Member
Member
Member
Member
Member
Member
Member
Member
Member
Member
Member
Member
Member
Member
Member
Member
Member
Member
Member
Member
Member
Member
Secretary

President and Vice-President are Permanent Invitees to all the Committees

the management accountant, August, 2009

603

Cover Feature

Financial Engineering:
Recent Instruments in
Corporate Finance
"Financial engineering is the life blood of financial innovation. It is the
application of investment technology in an effort to solve financial problems.
Various types of products like options, futures, floating rate notes, zero interest/
deep discount bounds, junk bonds, ADR/GDRs etc. are innovated by financial
engineers to split the risk and return into several components. Financial
engineers are employed by commercial banks, investment bank, a variety of
other financial intermediaries and non -financial corporations. Financial
engineers work as a part of team work. Their role in global financial markets is
remarkable. The present paper aims to highlight the concept of financial
engineering and its scope and some recent developed instruments in corporate
finance.

Dr. S.S. Chahal*


Vijay Singh Hooda**
Introduction
inancial engineering has been one
of the emerging disciplines of the
past decades. It is the latest
terminology addition to the world of
finance. After industrial and social
engineering, we have the financial
engineering. In today's highly volatile
markets, it seeks to limit the financial
risk to limit the financial risk by creating
financial instruments for hedging,
speculation, arbitraging and by finetunning portfolio adjustments. Financial
engineering has completely changed
the financial market today. Various
types of innovations are seen in bonds,
equity, derivatives and also in the other
fields like merger, acquisition and
corporate restructuring. The present
article aims to give the conceptual
framework of financial engineering and
various financial instruments innovated
in last some decades.

* Professor, Department of Commerce,


M.D. University, Rohtak (Haryana)
** Research Scholar, Department of
Commerce, M.D. University, Rohtak
(Haryana)

604

Conceptual Framework of Financial


Engineering
Financial engineering basically
means financial innovations. It
connotes the development of new
financial technology to cope with
financial changes. It means the
formulation of creative solutions to
problems in finance. It encompasses the
design, analysis and construction of
financial contracts to meet the needs of
enterprise and investors. It is a process
that seeks to adopt existing financial
instruments and the develop new
products/ instruments to enable
financial market participants to cope
more effectively with the changing
world. John Finnerty described it as
"Financial engineering involves the
design, the development and the
implementation of innovative financial
instruments and process and the
formulation of creative solutions to
problems in finance."
The words "innovative and
creative" given in definition are most
important to know the real concept of
financial engineering. Thus, financial

engineering is the application of


investment technology in an effort to
solve financial problems.
Scope of Financial Engineering
Financial engineering is not limited
to corporate and institutional
applications. Many of the most creative
financial innovations in recent years
have been directed at the retail.
Financial engineering is practiced at
both commercial banks and investment
banks. Commercial banks involved in
engineering solutions to corporate
clients often regard their financial
engineers as part of their investment
banking operations. For this reason,
the term 'investment bank' includes
traditional investment banks,
commercial banks involved in financial
engineering and other parties involved
in structured deal making and risk
management activities.
Financial engineers are involved in
corporate finance, trading, investment,
and money management, and risk
management. In corporate finance,
financial engineers are often called
upon to develop new instruments to
secure the funds necessary for
operation of large-scale businesses.
They play vital role in mergers and
acquisitions (M & A). The introduction
of junk bonds and bridge financing to
secure the funds necessary for
takeovers and to secure the funds
necessary for takeovers and leverage
buyouts (LBOs) are the example of
engineering skills in mergers &
acquisitions
(M & A). Financial
engineers are employed in securities
and derivative product trading. They
are particularly adept at developing
strategies of an arbitrage nature. These
arbitrage strategies can involve
opportunities across space, time,
instruments, risk, legal jurisdiction or
tax rates.
Financial engineers play a
tremendous role in investment and
money management. They have
developed new investment vehicles

the management accountant, August, 2009

Cover Feature

such as "high yield" mutual funds,


money market funds, sweep system and
repo market. They are heavily involved
in risk management. They work with the
client firm to identify risks, to measure
the risks, and to determine the kinds of
outcomes the firm's management would
like to achieve.
Hence, financial engineers play
three roles: deal markers, idea generators
and loophole exploiters. Successful
financial engineers are always well
versed in the areas of financial theory,
which are relevant to their trade and
mathematical relationships, which make
their deals work. They tend to grasp
ideas quickly, and easily see through
the details of basic components of a
structure.
Instruments / Tools of Financial
Engineering
Like an engineer, the successful
financial engineer needs a toolkit. The
financial instruments may be divided
into four broad classes: equities, debt,
derivatives and hybrids. Financial
engineers use off the shelf financial
products when existing products are
unsuitable to accomplish a given
objective, or when the structure of new
product is such that it will create new
opportunities for the innovating firm or
for the firms clients. The tools /
instruments used by the engineers are
as follows:
Innovation in Derivatives
Options: An option is right, but not
the obligation, to buy or sell something
at a stated date at a stated price. In deep,
an option contract gives the holder of
the contracts the option to buy or sell
shares at a specified on or before a
specific date in future. The buyer of the
contract has option to buy or sell shares
at a specified on or before a specific
date in future. The buyer of the contract
pays the writer (or seller) for the right,
but not the obligation, to purchase
shares etc. to the writer at the price fixed
by the contract (the striking or exercise

price). Options are categorized into (i)


call option (right to purchase) and (ii)
put option (right to sell).
Swaps: A swap can be defined as
the exchange of one stream of future
cash flow with another stream of cash
flows with different characteristics. In
other words, a swap is an agreement
two or more people/parties to exchange
sets of cash flows over a period in
future. Swaps can be divided in two
types viz. (a) currency swaps (b)
interest rate swaps. Currency swaps are
agreements whereby the currencies are
exchanged at a specific exchange rates
and specified intervals. The basic
purpose of swaps is to lock in the rate.
Interest rate swap is an agreement
whereby one party exchange one set of
interest rate payments for another. Most
common agreements is an exchange of
fixed interest rates over a time period.
The interest rates are calculated on the
notional value of principals.
Forward contract: A forward
contract is an agreement made between
and buyer and seller to exchange the
commodity or instrument for cash at a
predetermined future date at a price
agreed upon today. In a forward
contract, two parties agree to do a trade
at some future date, at a stated price
and quantity. No money exchanges
hands at the time the deal is signed.
Futures contract: A future contract
is a financial security, issued by an
organized exchange to buy or sell a
commodity, security or currency at a
predetermined future date at a price
agreed upon today. The agreed upon
price is called the 'futures' price. Futures
are exchange traded contracts to sell or
buy financial instruments or physical
commodities for future delivery at an
agreed price. This is an agreement to
buy or sell a specified quantity of
financial instruments / commodity in a
designated future month at a price
agreed upon by the buyer and seller.
The contract have certain standardized
specifications. Futures contract may be

the management accountant, August, 2009

classified into two categories, viz. (1)


Commodity futures (2) Financial futures
Innovations in Equity
Sweat Equity Shares: Under section
79A of the Companies Act, 1956, a
company can issue sweat equity shares
to is employees or directors at discount
or for consideration other than cash for
providing know-how or making
available rights in the nature of
intellectual property rights or value
addition etc.
Green Shoe Option: Green shoe
option denotes an option of allocating
shares in excess of the shares included
in the public issue. It is an option
allowing the issuing company to issue
additional shares when the demand is
high for shares when the flotation is on.
SEBI guidelines allows the issuing
company to accept over subscription,
subject to a ceiling, say 15% of the offer
made to public. In certain cases, the
green shoe option can be even more
than 15%. It is extensively used in
international IPOs to stabilize the post
listing price of new issued shares.
Employee stock option plan (ESOP):
ESOP means the option given to the
whole time directors, officers or
employees of a company, which gives
such directors, officers or employees the
benefit or right to purchase or subscribe
at a future date, the securities offered
by the company at pre-determined price.
ESOPs usually means of supplementing
employees salaries with the right to buy
shares in the company at a price less
than the market price.
Non voting shares: Non voting
shares are closely akin to preference
shares which do not carry any voting
rights nor is the dividend payable
predetermined. However, unlike
preference capital, non-voting shares do
not carry a pre-determined dividend.
Promoters of companies are likely to
find favor with this instrument since it
protects their controlling interest. Small
investors and institutional investors are
605

Cover Feature

not interested in voting rights of good


companies and they are happy with
additional dividend to exchange the
voting rights.
Innovations in Debt Market
Fixed income securities: the fixed
income security markets are one of the
favorite stomping ground of financial
engineers. Fixed income securities are
those private and public sector issues
that meet anyone of three criteria:
(1) pay a fixed sum such each period.
(2) pay a sum to be determined by a
formula (3) guarantee a fixed sum upon
maturity.
Treasury bills: These are issued in
maturities of three months (13 weeks or
91 days), six months (26 weeks or 182
days) and one year (52 weeks or 364
days). They are sold at a discount from
face value and redeemed at face value.
The interest is then amount of the
discount. For this reason, these
instruments are collected views as short
maturity zero coupon bonds.
Commercial paper: Commercial
paper is an unsecured promissory note
with a maturity of 210 days or less. It is
an effective financing tool for firm with
investment grade ratings when funds
are only needed for a short period of
time. It is also used as the foundation
of an intermediate to long-term
financing strategy.
Certificate of deposits: A CD is a
receipt from a bank for funds deposited
at the bank for a specific period of time
and at a specific rate of interest. CDs
have maturities of at least 7 days and
can run to several years.
Mortgage bonds and debentures:
Security can take the form of a pledge
of real property, a pledge of personal
property, or a guarantee by another
entity. Bonds seemed by real property
are called mortgage bonds. When no
security or guarantee is available, the
issue is called a debenture.
Preferred stock: Preferred stock is
a class of equity that endows its owners
606

with certain erences over common


stockholders. Preferred stock is, in
many ways, similar to debt. Never tellers
it is equity, unlike common stock,
preferred stock ordinarily pays a fixed
dividend.
Floating rate notes: Floating rate
debt, also sometimes called variable rate
debt is an obligation in which the interest
rate is periodically reset in response to
changing market conditions. These
corporate instruments are collectively
called floating rate notes. These are
bond type debt instrument that have
floating rate coupons rather than the
floating rate coupons that characterize
more conventional long - term debts
instruments.
Recent Debt Market Instruments
Zero interest bond (ZIB) : It refers
to those bonds which are sold at
discount from their eventual maturity
period and have zero interest rate. These
certificates are sold to the investors for
discounts. The difference between the
face value of the certificate and the
acquisition cost is the gain to the
investors. The individual investors
prefers ZIB because of lower investment
cost and low rate of conversion to
equity. ZIBs are fully or partly
convertible bonds.
Equity warrants with NCDs: Equity
warrant is a piece of paper attached to a
non - convertible debentures which
gives the buyer or holder right to apply
for and acquire an equity share at a
future date. The equity warrants
increases the marketability of
debentures and reduces the need for
the efIorts for brokers / sub-brokers by
way of private placement. They provide
assured rate of interest over life on non
- conveliible debentures.
Secured premium notes (SPN) :
The SPN is a tradable instrument with
detachable warrant against which the
holder gets equity shares after a fixed
period of time. The SPN have features
of medium to long-term notes. With
each SPN, a warrant may be attached to

it, which will give the holder the right to


apply for and get allotment of equity
shares after certain period of time by
which the SPN will be fully paid up.
Deep Discount Bond (DDB): Its
acquisitions cost is very less as compare
to the face value of bond. The IDBI for
the first time issued deep discount bond
(DDB). For a deep discount price of Rs.
2700, an investor gets a bond with a
face value over the maturity period of
25 years. The unique advantage of DDB
is the elimination of investment risk. It
is safe, solid and liquid instrument.
Zero Coupon Convertible Note: It
is an instrument which can be
converted into common stock of the
issuer. If investors choose to convert
they will be required to forego all
accrued and unpaid interest. Zero
coupons can generally be put to the
issuer. This allows the issuer to obtain
the advantages of convertible debt
without too much dilution of common
stock. Like any zero coupon bond the
issuer gets a tax deduction for imputed,
even though no cash is paid till maturity.
Warrants: A warrant entitles its
holders to subscribe to the equity
capital of a company during a specified
period at stated price. The holder
acquires only the right but no obligation
to acquire the equity shares. Warrants
are generally issued in conjunction with
other instruments like secured premium
notes and debentures.
Debt for equity swap: This
instrument is an offer from as issuer debt
securities to its debt holders to exchange
the for the issuer common or preferred
stock. The issuer who wishes to offer
debt for equity swaps does so with a
view to increasing equity capital for the
purpose of improving its debt equity
ratio and also enhance its debt raising
capacity. It also helps issuer to reduce
their in interest expenses and enables
them to replace it with dividends on
stock that are payable at their discretion.
Multi option secured redeemable
convertible debentures: Where a

the management accountant, August, 2009

Cover Feature

debenture gives the holder two or more


different options, it may be called a multi
- option debenture. It is a species of
debenture, it is essentially a debenture
in character and is secured redeemable
and convertible into equity shares.
Callable bonds: A callable bond is a
bond which the issuer has the right to
call in and payoff at a price must pay
retire a callable bond when it is called is
termed as 'call price'. The main benefit
in callable bond is the issuers have an
incentive to call their existing bonds if
the current interest rate in the market is
sufficiently lower than the bonds
coupon rate.
Junk bonds: Junk bonds, also
known as high yield and as speculative
grade bonds are bonds having a less
than investment grade rating. For many
decades, such bonds were usually not
issued as such but rather were issued
as investment grade and subsequently
deteriorated to speculative grade. Junk
bonds are high yield security because
a widely used source of finance in
takeovers and leveraged buyouts.
Firms with low credit ratings are willing
to pay 3 to 5 percent more than the high
grade corporate debt to compensate for
the greater risk.
Inflation adjusted bonds (IABs) :
IABs are bonds which promise to reply
both the principal and the interest, by
floating both these amounts upwards
or downwards in line with the
movements in the value of the specified
index of commodity prices (Inflation
rate).
Coupon shipping: It means
separation of the principle part and
interest part of an ordinary bond, and
selling them separately to the investors.
It is also known as bond stripping or
just scripts. This instrument is very
popular in developed money markets.
The stripping result in two securities,
one from the principal part and the other
from the interest part, which is known
as strip. The principal part is structured
as a zero coupon bond which is issued

and traded at a discount and redeemed


at its face value at the maturity. The
interest part can be structured as a zero
coupon bond or any other structured
instrument.
Innovative Products in International
Capital Market
Global Depository Receipts
(GDRs): A GDR is an instrument which
allow Indian corporate, banks, nonbanking financial companies etc. to raise
funds through equity issues from
abroad to augment their resources for
domestic operations. It is a dollar
dominated instrument of a company,
traded in stock exchanges outside the
country of origin. Though the GDR is
quoted and traded in dollar terms, the
underlying equity shares are
denominated in rupees only. The main
advantage to the issuer is that he does
not assume any exchange risk, though
he does enjoy the benefit of foreign
exchange collected by way of issue
proceeds.
Foreign currency convertible
bonds (FCCBs): FCCBs are issued in
accordance with the scheme and
subscribed by a non resident in foreign
currency and convertible into ordinary
share of the issuing company in any
manner, either in whole or in part on the
basis of only equity related warrants
attached to debt instrument. The FCCB
is almost like the convertible debentures
issued in India.
American depository receipts
(ADRs): A foreign company might make
issue in U.S. by issuing securities
through appointment of bank as
depository. By keeping the securities
issued by the foreign company, the U.S.
bank will issue receipts called American
Depository Receipts (ADRs) to the
investors. It is a negotiable instrument
recognizing a claim on foreign security.
Hybrid Securities
Interest rate / foreign - exchange
hybrid: Dual currency bond is a good
example of an interest rate / foreign
exchange hybrid. It is a fixed rate bond

the management accountant, August, 2009

with interest payments denominate in


one currency. For example a 5 year bond
with a coupon of 12 % payable annually
in U.S. dollars.
Interest rate / equity hybrid: An
interest - rate / equity hybrid would
combine an interest-rate element and on
equity element in the overall return for
the security. Consider a 3-year bond
issued with a dollar dominated fixed rate
of interest of 10% per annum paid
annually and redemption value upon
maturity tied to an equity index.
Currency / commodity hybrid: In a
currency commodity hybrid the total'
return on the hybrid security is a
function of the elemental return on the
price of a commodity such as oil.
Financial Engineering in India
In Indian markets, there is excessive
speculation and there is structural and
organizational imbalances in the growth
of stock markets. There is no positive
relation between price movements and
volume of new issue. Indian stock
markets are characterized by various
unethical practices. These factors are
seriously hampering financial
innovation in Indian markets. Indian
stock exchanges are mostly
oliogoplostic in nature and weak clients
often become the victims to pay badla
charge which violates the trading
norms. The legal authorities have issued
a number of guidelines to stock
exchanges, banks, financial institutions,
companies, merchant bankers, brokers
and other intermediaries to improve the
working of stock exchanges. Still equity
culture and sound functioning of Indian
stock markets are weak in practice and
which in turn is seriously hampering the
financial engineering process and its
related advantages. Till the mid - 1980,
the Indian financial markets did not see
much innovation but in last 5 decades,
various types of products like deep
discounts bonds, zero coupon bonds,
floating rate bonds, debt - oriented
mutual funds, money market mutual
Contd. on Page 614
607

Cover Feature

Z - Score Analysis - A
Tool to Predict Financial
Health

2. To predict the financial health and


viability of Mahindra and Mahindra
limited and Eicher Motors.
Methodology of the study

The Z score is a measure of a company's health and utilizes several key ratios for
its formulation. Having understood the causes for a firm's sickness, the next
important question is - is it possible to predict a firm's failure using some modeling
technique with reasonable accuracy
This paper analyses possibility of firm's failure with reasonable accuracy by
using statistical tool Z - score, developed by Altman. This empirical analysis
concentrates on the heavy commercial vehicle industry companies Mahindra &
Mahindra Company limited and Eicher listed in Bombay Stock Exchange India

Dr. K. Venkat Janardhan Rao*


M. Durga Prasad**

usiness failure occurs due to


different reasons. While few
firms within first year to life, few
others grow, mature and fail much later.
The failures occur in a number of ways
and also from different reasons. The
following are the important reasons for
failure of business firms' failure.
1. An imbalance of skills within the top
echelon
2. A chief executive who dominates a
firms operations without regard for
the inputs of peers
3. An inactive board of directors. The
board of directors' lack of interest in
the financial position of the
company may lead to insolvency.
4. A deficient finance function within
the firm's management
5. The absence of responsibility for
the chief executive officer
6. Management may be negligent in
developing effective accounting
system
7. The company may be unresponsive
to change

8. Management may be inclined to


undertake an investment project
that is disproportionately large
relative to firm size. If the project
fails the probability of insolvency
is greatly increased.

*Associate Professor, University P.G.


Centre, Kakatiya University, Khammam.
**Faculty Member, Badruka Institute of
Foreign Trade, Hyderabad.

1. To examine the overall financial


performance of Mahindra and
Mahindra limited and Eicher
Motors.

608

Having understood the caused for


a firm's sickness, the next important
question is ; is it possible to with
reasonable accuracy predict a firm's
failure using some modeling technique.
Research shows that as a company
enters the final stage prior to failure - a
pattern may develop in terms of
changing financial ratios, which prove
to be useful indicators of an impending
disaster. Altman has developed a
statistical model and found the
statistical ratios best predicting
bankruptcy. Based upon Altman's
sample of bankrupt firms the study
yielded an equation that used five ratios
to predict bankruptcy.
Objectives of the study
The objectives of the study are as
follows

The Z-Score is a measure of a


company's health and utilizes several
key ratios for its formulation. The model
was developed in the late 1960's by
Edward I. Altman, professor of finance
at New York University School of
Business. The model incorporates five
weighted financial ratios into the
calculations of the Z-Score.
Z-score Analysis
X1 Component of Z-Score is defined
as (X1=Working Capital/Total Assets).
The ratio of Working Capital to Total
Assets is the Z-Score component,
which is considered to be a reasonable
predictor of deepening trouble for a
company. A company which
experiences repeated operating losses
generally will suffer a reduction in
working capital relative to its total
assets.
1. The X2 Component of Z-Score is
defined as (X2=Retained Earnings/
Total Assets). The ratio of Retained
Earnings to Total Assets is a Z-Score
component, which provides
information on the extent to which a
company has been able to reinvest
its earnings in itself. An older
company will have had more time to
accumulate earnings so this
measurement tends to create a
positive bias towards older
companies.
2. X3 Component of Z-Score is defined
as (X3=Earnings Before Interest and
Taxes /Total Assets). This ratio
adjusts a company's earnings for
varying income tax factors and
makes adjustments for leveraging
due to borrowings. These
adjustments allow more effective
measurements of the company's
utilization of its assets.

the management accountant, August, 2009

Cover Feature

ANALYSIS
MAHINDRA & MAHINDRA LIMITED
TABLE I
STATEMENT SHOWING THE FINANCIAL DATA

Mar 2004 Mar 2005


12 mths
12 mths
2,908.96 4,086.87
1,955.19 2,657.76
953.77 1,429.11
1,897.21 2,294.69
772.43 1,172.57
41.52
50.68
461.29
495.71
6,972.71 9,361.75
7,618.08 10,053.66

Particulars
Rs. Crore (Non-Annualized)
Current assets
Current liabilities
Working capital
Retained Earnings
EBIT
Book Value (Rs)
Market Value(Rs)
Total assets
Sales
3. The X4 Component of Z-Score is
defined as (X4=Market Value of
Equity/Book Value). This ratio gives
an indication of how much a
company's assets can decline in
value before debts may exceed
assets. Equity consists of the market
value of all outstanding common
and preferred stock. For a private
company the book value of equity
is used for this ratio. This depends
on the assumption that a private
company records its assets at
market value.
4. The X5 Component of Z-Score is
defined as (X5=Net Sales/Total
Assets). This ratio measures the
ability of the company's assets to
generate sales. This ratio is not
included in the Z-Score of a private
company.
The Z-Score is: Z = 1.2 X1 + 1.4 X2 + 3.3
X3 + 0.6 X4 + 0.999X5.
The resulting Z-score puts a
company in one of three categories.
Companies with a Z- score above
3.0 are considered Healthy
Companies with a Z-score less than
1.8 indicates a high probability for
bankruptcy in the next 1- 2 years

Mar 2006 Mar 2007 Mar 2008


12 mths
12 mths 12 mths
5,600.77 8,439.37 10,560.76
3,352.37 5,202.91 6,720.81
2,248.40 3,236.46 3,839.95
3,488.22 4,616.72 5,925.70
2,079.10 2,618.50 3,198.50
81.95
92.63
137.93
631.51
726.36
689.29
13,535.60 20,157.80 26,361.90
12,972.82 18,274.58 24,712.84
TABLE II

STATEMENT SHOWING THE RATIOS OF MAHINDRA & MAHINDRA


Working capital / Total assets (X1)

0.14

0.15

0.17

0.16

0.15

Retained earnings / Total Assets (X2)

0.27

0.25

0.26

0.23

0.22

EBIT / Total Assets (X3)

0.11

0.13

0.15

0.13

0.12

Market value / Book value (X4)

0.09

0.10

0.13

0.13

0.20

Sales / Total assets (X5)

1.09

1.07

0.96

0.91

0.94

TABLE III
STATEMENT SHOWING THE Z SCORES OF MAHINDRA & MAHINDRA
Year

1.2X1

1.4X2

3.3X3

0.6X4

0.999X5

Mar, 2004

0.16

0.38

0.37

0.05

1.09

2.06

Mar, 2005

0.18

0.34

0.41

0.06

1.07

2.07

Mar, 2006

0.20

0.36

0.51

0.08

0.96

2.10

Mar, 2007

0.19

0.32

0.43

0.08

0.91

1.92

Mar, 2008

0.17

0.31

0.40

0.12

0.94

1.95

Companies with a Z-score 1.8 to 3.0


are considered within "gray area".
Data Collection
The study is concerned with the
analysis of financial health of Mahindra
and Mahindra limited and Eicher Motors
and it has been confined to only two
companies in the private sector. This
study is mainly based on Secondary
data. The required information about

the management accountant, August, 2009

two companies for the Z-score analysis


was obtained from the Prowess
database for a period of five years
(March, 2004 to March, 2008)
Inference:
The resulting Z-score puts a
company in one of three categories.
Companies with a Z score above 3.0 are
considered healthy. A Z score less than
1.8 indicates a high probability for
609

Cover Feature

EICHER MOTORS LTD


TABLE IV
STATEMENT SHOWING THE FINANCIAL DATA
Eicher Motors
Rs. Crore (Non Annualized)
Current assets
Current liabilities
Working capital
Retained earnings
EBIT
Book Value (Rs)
Market Value (Rs)
Total assets
Sales

bankruptcy in the next 1-2 years. Scores


of 1.8-3.0 are considered within "gray
area".
From the year 2004-07, it is clear that
the Z Score of M&M is between 1.8
&2.7 that means the company is there
under Grey Zone and its financial
viability is considered to be healthy.
The failure in this situation is uncertain
to predict.
During the period from 2004 to 2008,
a period of five years, the Z score of
Eicher Motors are more than 3.0 that
means the company is in good position
and the unit is in too healthy, its
financial position is viable and not to
fall.
The above five financial ratios cited
are used in the equation for judging the
financial health of M&M motors and
Eicher motors limited. In the year 2006,
M&M motors limited, the contents of
the working capital towards the total
assets is more and it does/not show the
favorable conditions and it effects the
financial position of the company. But
after comparing the financial
performance of both the companies,
performance of Eicher motors limited is
better than M&M
610

Mar 2004

Mar 2005

Mar 2006

Mar 2007

Mar 2008

12 mths

12 mths

12 mths

12 mths

12 mths

434.45
428.08
6.37
166.83
117.39
93.42
221.17
381.87
1,372.00

517.72
545.25
-27.53
212.86
108.1
85.77
306.55
369.63
1,995.77

494.98
450.18
44.8
416.92
174.91
158.4
302.64
618.26
1,649.38

625.76
592.01
33.75
385.28
160.97
147.14
238.32
608.76
1,968.64

644.42
599.32
45.1
430.24
180.91
163.14
248.17
656.15
2,218.83

TABLE V
STATEMENT SHOWING THE RATIOS OF MAHINDRA & MAHINDRA
Working capital/ Total assets (X1)

0.02

-0.07

0.07

0.06

0.07

Retained earnings /Total Assets (X2)

0.44

0.58

0.67

0.63

0.66

EBIT / Total Assets (X3)

0.31

0.29

0.28

0.26

0.28

Market value /Book value (X4)

2.37

3.57

1.91

1.62

1.52

Sales /Total assets (X5)

3.59

5.40

2.67

3.23

3.38

TABLE VI
STATEMENT SHOWING THE Z SCORES OF MAHINDRA & MAHINDRA

Year

1.2X1

1.4X2

3.3X3

0.6X4

0.999X5

Mar,2004
Mar,2005
Mar,2006
Mar,2007
Mar,2008

0.02
-0.09
0.09
0.07
0.08

0.61
0.81
0.94
0.89
0.92

1.01
0.97
0.93
0.87
0.91

1.42
2.14
1.15
0.97
0.91

3.59
5.39
2.67
3.23
3.38

6.66
9.22
5.78
6.03
6.20

TABLE VII
COMPARATIVE STUDY
Year

M&M

Change

Eicher

Change

Mar,2004

2.06

6.66

Mar, 2005

2.07

0.86%

9.22

38.53%

Mar, 2006

2.10

1.37%

5.78

37.36%

Mar, 2007

1.92

8.47%

6.03

4.35%

Mar, 2008

1.90

1.18%

6.20

2.88%

the management accountant, August, 2009

Cover Feature

Revamping Global
Financial Architecture:
an overview
Intrinsic flaws in global financial architecture are the root cause of recurrence
of financial turmoil. The need was felt from every corner to guard against the
systematic risk. Dollar dominance international market expedited the countries'
woes while the US economy took its advantage in mitigating her burgeoning
year long trade deficits in view of keeping the pace of consumption glut, and
lowering exchange rate risk and borrowing costs.
Recent step to add more lending funds of IMF to bail the crisis of the century out
is a short term measure and may not rescue the world of revisiting financial
meltdown. In course of analysis of the present status of SDR the paper argued
the need for international reserve currency, redefined SDR, disconnecting from
individual nation (US) which would eliminate the inherent risks in a credit
based currency (like Dollar) and manage global liquidity. Further, when a
country's currency is no longer used as the yardstick for global trade and as the
benchmark for other currencies, the exchange rate policy of the country would
be far more effective in adjusting economic imbalances. This will significantly
reduce the risks of future crisis. Thus, revamping of dollar dominance financial
architecture is needed to have international reserve currency through the process
of sharing of political power across more diverse set of nations.

Dr. R. K. Raul*
Introduction:
xuberance of economic slump, in
the present integrated global
economy, perhaps deepest in the
post world war II period, does not seem
to be blown out. The attempts to bail
'the crisis of the century' out across the
countries are not producing instantaneous consequences. Economic
stimulus across the globe may succeed
subject to restoring the level of
confidence1. The Washington summit,
November 2008, in this respect
emphasized a closer surveillance of
functioning of all those markets,
territories and actors (especially hedge
funds which accounts 50 pc of market
transaction and are not subject to rules
on transparency) putting global

Professor, Department of Business


Administration, Assam University, Silchar
Email: rkraul@yahoo.com

financial system at risk . The leaders of


the G-20 summit in their statement '
global plan for recovery on an
unprecedented scale' also reiterated
stricter limits on hedge funds , credit
rating firms, over-leveraging, outsized
financial institutions, risk- taking by
banks, and executive pay. Moreover,
the summit recognized the fundamental
flaws in the present global financial
architecture and called for measures to
guard against the systematic risk
leading to recurrence of global financial
crisis.
With this backdrop an endeavour
has been made hereunder to reveal the
origin of recurrence of world's financial
crisis and throw light on possible
curative measures pertaining to global
financial predicaments.
World's concern about the crisis of the
century.
The world leaders expressed their

the management accountant, August, 2009

apprehensions about the world


economy in both the Washington
(November 2008) and London (April 2,
2009) summit. In view of impending
financial threats and liquidity crunch
emanated from financial system, the G20 leaders in London summit pledged a
$1.1 trillion aid to revive the global
economy. An amount of $500bn was
earmarked for IMF's extra lending to the
liquidity trodden countries across the
globe. Further the leaders authorized the
IMF to release $250 billion to its member
countries to bail the financial crisis out
to an immediate effect. Consequently,
the reserves of emerging countries will
be substantial and rich countries will
gain more as they enjoy lion share of
existing IMF's quota. Interestingly,
China's vast reserves nearly $2 trillion
at present will further swell up $9.3
billion.
Effect of IMF's quantitative easing
Countries
Percentage increase
in reserve($)
South Korea
3.4
India
4.8
Brazil
3.5
Russia
6.9
China
7.3
This apart, the decision to establish
Financial Stability Board (FSB) with
representatives of all G-20 to oversee
the global financial system and to
establish an early warning system are
some of the epoach making decisions
were made where the voice of countries
like India to be heard.
Allocation and country wise share
Countries
Share
Existing Proposed Gain/Loss
US
16.77
16.73
(-).04
Japan
6.02
6.22
0.20
UK
4.86
4.39
(-).47
France
4.86
4.39
(-).47
China
3.66
3.81
0.15
Russia
.69
2.39
1.70
Belgium
2.09
1.86
(-).23
India
1.39
2.34
0.95
South Korea 1.38
1.36
(-).02
Brazil
1.38
1.72
0.34
Source: IMF

611

Cover Feature

Despite, the real root of present


crisis along with preventive measures
of recurrence of global financial crisis
perhaps remains unresolved i.e. the role
of US dollar and linked to that, global
imbalance. The US administrations
though are in denial mode to accept the
issue but the fact remains that the dollar
supremacy is fading out and its
profligacy posed threat to world's
growth.
Dollar and substitution Account.
The US dollar holds key position in
the international reserve currency. As a
result other countries have limited
alternatives but to invest in the US
dollar. The developing countries lend
dollar to US almost at zero interest rate
when they are in bare need of that
money (Joseph Stiglitz)3. This
facilitates US Fed to lower its borrowing
costs, funding both the domestic over
consumption and burgeoning trade
deficits by printing dollars/Treasury
Bills. Since 2000, the US has been living
beyond its means in a big way and its
expenditures exceeded about $600
billion per year during 2000-07. In late
2007, foreign dollar holdings were
estimated to be at least $20 trillion. To
cap it all the US is trying to cure its earlier
profligacy by running it huge deficit
budget and reckless use of the printing
press. This resulted in nervousness
amongst the holders of US dollars. If
the pace of unwillingness to accept
dollars increases, the international
payment system would be collapsed in
absence of an alternative international
currency leading the world into a great
depression.
It is with these reasons the concept
of substitution Account was mooted in
1971. The underlying idea was that the
official holders of dollars can deposit
their unwanted dollars in a special
account in the IMF with the values of
deposits denominated in an
international currency such as the SDR
of the IMF (Madhu, Vij). This ultimately
will facilitate the countries to maintain
612

the value of their reserves intact.


However, denial mode of the USA led
to nip the substitution account idea in
the bud.
SDR: its pitfalls.
As per IMF2, the SDR is an
international reserve asset created in
1969 to supplement the existing official
reserves of member countries. It serves
as the unit of account of the IMF and
some other international organizations
and its value is based on a basket of
key international currencies. Initially
SDR was defined as equivalent to
0.888671 grams of fine gold and at that
time it was equivalent to one US Dollar.
After the collapse of the Bretton Woods
system in 1973, SDRs was redefined as
the basket of world's major currencies
particularly the US$, Yen, Euro (Mark
and Franc were replaced since 1999)
and the UK Pound Sterling used in the
international trade and finance. The
determination of the currencies in the
SDR basket and their amounts is made
by the IMF Executive Board in every
five years. Further the amounts of each
currency making up one SDR are chosen
in accordance with the relative
importance of the currency in
international trade and finance. SDRs
are allocated to member countries in
proportion to their IMF quotas. The
exact position of each currency in the
SDR basket is seen in the following
table:

Though the SDR was started in the late


sixties but did not really take off due to:
l shift of world's major currencies to
floating rate regime in the context of
collapse of Bretton Woods system
and
l robust of growth of international
capital market with borrowings by
the credit worthy governments.
Presently, the SDR has only limited
use as reserve assets. It serves as
potential claim on the freely usable
currencies of IMF members. The holders
of SDR can obtain other currencies
through arrangement of voluntary
exchanges between members and
purchase SDRs from members with
weak external positions. The major
pitfalls is that the constituents of SDR
i.e.US Dollar, Euro and UK Pound, since
late 2000s are losing value against a
larger basket of secondary reserve
currencies : Chinese Renminbi ( Yuan)
Indian Rupee , Canadian Dollar,
Australian Dollars. Moreover, the
reserve of China, India and petrodollar
state i.e. Gulf States (Gold/Silver/
Platinum/Palladium) are not equivalent
in size to the US's and are potentially
undersized for the current recessionary
conditions.
Thus, redefinition of SDR is
necessitated in terms of major currencies
of the world. Indian rupee, Chinese Yuan
should be used as unit of account for

Basket of 1 SDR

1981-85
1986-90
1991-95
19961998
1999
2000
2001
2005
2006
2010

US Dollar

Deutsche
Mark

French Franc

Japanese Yen

UK Pound

0.540 (42%)

0.460 (19%)

0.740 (13%)

34.0 (13%)

0.0710 (13%)

0.452 (42%)
0.572 (40%)

0.527 (19%)
0.453 (21%)

1.020 (12%)
0.800 (11%)

33.4 (15%)
31.8 (17%)

0.0893 (12%)
0.0812 (11%)

0.582 (39%)

0.446 (21%)

0.813 (11%)

27.2 (18%)

0.1050 (11%)

US Dollar
0.5820
(39%)
0.5770
(45%)
0.6320
(44%)

Euro

Japanese Yen

UK Pound

0.3519 (32%)

27.2 (18%)

0.1050 (11%)

0.4260 (29%)

21.0 (15%)

0.0984 (11%)

0.4100 (34%)

18.4 (11%)

0.0903 (11%)

Source: IMF
the management accountant, August, 2009

Cover Feature

trade and investment and maintaining


liquidity. Over the time it would become
principal international currency without
depending on currency of individual
country.
Asia beeline for US Bonds: consequences.
The Bretton Woods system failed
in 1971. The root causes of such failure
were attributed to loss of faith on dollars
that started losing credibility to convert
itself into gold at a promised rate of $35
per ounce of gold. Despite, most
countries around the world have been
holding a major part of their reserve in
the form of the US treasury bills. The
momentum of such flow remained
uninterrupted during the global
meltdown.
These uninterrupted flows of
currencies around the world are parked
in the US dollar that enable the US to
print T Bills and manage its burgeoning
trade deficits and maintained its
consumption glut. The china is recently
opposing dollar's supremacy and
advocating SDR as an alternative to
dollar still it has emerged as major
investors in the US treasury bills.
Besides, central banks of Asian
countries except Korea have parked
their reserves in T Bills. And such flows
have not been slowed down in the
context of US Federal Reserve Board
bringing down its key rates by 175bps
in September 2008 and yields on 10 year
US treasuries have declined below 1
percent. The fillip side of such action is
that the central banks around the world
want to preserve the capital in the crisis
hit situation but the grey areas include
the country like India where domestic
borrowing is made at 9 percent and
lending it to the US at 3 percent thereby
making a loss of about 6 percent per
every dollar held in the form of US
treasury Bills (Subhada, 2009)4.
The dollar's most important
advantage is the size, quality, and
stability of dollar asset markets,
particularly the short-term government
securities market where central banks

Major Asian Investors in US treasury securities ($ billion)


Country

Feb 2009

Sept 2008

Absolute variation

Percentage variation

China

744.2

618.2

126.0

20.38

Japan

661.9

617.5

44.4

7.19

Hong Kong

76.3

65.5

10.8

16.49

Taiwan

72.6

63.5

9.6

15.24

India

34.6

20.3

14.3

70.44

Korea

33.3

40.2

-6.9

-17.16

Philippines

12.6

12.0

0.6

5.0

Singapore

39.4

32.2

7.2

22.36

Thailand

39.7

27.4

12.3

44.89

Source : US treasury
tend to be most active. The high
liquidity of these financial markets
makes the dollar an excellent medium of
exchange. A further advantage is the
power of "incumbency" conferred by
the "network-externalities" that accrue
to the currency that is dominant.
Together these factors make it unlikely
there will be a large or abrupt change in
the dollar's reserve currency status5.
The central banks' preference around
the world for parking their currency in
US treasury Bills perhaps lies in the basic
philosophy of constructing portfolio.
Generally portfolio consisting of
financial assets including the foreign
currencies is constructed on the basis
of three criteria; return, risk and liquidity.
In this respect US treasury bills fulfill
all such criteria of high liquidity, with
low risk and low return. Moreover,
holding US treasury Bills serve twin
purposes;
Country (buyer) builds up its forex
reserve facilitating its international
transaction , and
The US issues T Bills to mitigate its
trade deficit and keep fuelling the
pace of its domestic consumption,
reduce exchange rate risk and lower
borrowing costs and indirectly
ensures world wide demand intact.
But, central banks' reserves with the
US across the world are losing its value
in the context of free fall of dollar. World
economies exclusively depending on
dollar movements thus witnessed
numerous financial predicaments;

the management accountant, August, 2009

exports suffered, import became costlier


and trade deficit mounted up.
Dollar dominance and need for new
financial architecture:
The central banks across the globe
hold reserve currency assets which are
known as official holdings. The volume
of such holdings has sharply increased
amounting to $5 trillion by the end of
2006. Out of these reserves Asia and
Japan account nearly $3 trillion. China's
official reserve has increased about $ 2
trillion and oil exporting countries
(petro dollar states) have accumulated
official reserves by about $700 billion.
However, 70 percent of these reserves
are kept in the form of dollar asset
giving number of advantages for the
US. As stated earlier, the US takes the
advantage in reducing borrowing costs
as well as the exchange rate risk.
Moreover, the foreign central banks,
important participants in the US
financial markets, have accelerated the
depth of US economy at cost of their
own country. The dollars share of total
official reserve rose to 72 percent of
global reserves in 2001. However, with
introduction of Euro in 1999 such share
fell down to 66 percent in 2003 and
remained almost same level through
2006. Once the euro seems to be great
contender of dollar but lost out since
Europe is unable to manage to get its
policy together. On the other hand the
emerging markets are developing
rapidly but are still small in size in
comparison to the US. All these led to
dollar to retain it significant position.
613

Cover Feature

Now the questions crop up how


long only sheer magnitude of dollar
assets in the official reserve could
accrue benefits to the US where the
dollar is continuously depreciating
against the major world currencies and
posing a threat to central banks in
respect of risk of incurring considerable
losses on holding dollar assets. The
solution perhaps lies in prudent asset
management. The primacy of the US
currency led the world into frequent
financial crisis. At this juncture need
arises for international reserve currency
disconnecting from individual nations
which would eliminate the inherent risks
in a credit based currency (like Dollar)
and manage global liquidity. Further,
when a country's currency is no longer
used as the yardstick for global trade
and as the benchmark for other
currencies, the exchange rate policy of
the country would be far more effective
in adjusting economic imbalances. This
will significantly reduce the risks of
future crisis.
Conclusion
It is apparent that world will be

plunged into great depression if dollar


dominance in the basket of
international currencies is seized with
an immediate effect. On the contrary, the
present system will accelerate the
momentum of woes of developing
countries affecting severely their
economy. At this juncture,
countervailing economic power in the
international forum especially the G-20
is emerging as a beacon of hope in the
global financial system and sharing
political power across more diverse set
of nations and enforcing serious reform
in global financial architecture. Thus
world's payment mechanism and market
structure favouring the dollar need to
be revamped with a view to have international reserve currency; a redefined
and restructured SDR as panacea for all
global financial predicaments.

3.
4.

5.
6.
7.
8.
9.

10.

References:
1. Christine Lagarde. New rules for finance
at last. The Economic times. March 31,
2009
2. Dress rehearsal for new Bretton Woods

11.

by Mythili Bhusnurmath. The Economic


Times
Special Drawing Rights. A factsheet
February 2008,IMF.
Subhada Sabade (2009). For a New
global currency. The Economics Time,
April24, 2009.
A brief guide to the IMF's currency.
The Economist, April 8.2009.
Madhu Vij. Multinational Financial
Management. Excel Books.
http://www.youtube.com/watch? v =
X192 r TX0zgI
http://www.youtube.com/watch? v =
Si2vXUJyATE
Antweiler, Werner. "Special Drawing
Rights: The SDR Fact Sheet(HTML).
University of British Columbia. http://
fx.sauder.ubc.ca/SDR.html.
h t t p : / / w w w. p b c . g o v. c n / e n g l i s h /
detail.asp?col=6500&id=178 . People's
Bank of China-Reform the International
Monetary System.
http://www.economist.com/finance/
displayStory.cfm?story id = 13382566
& source = features box2q

Contd. from Page 607


funds, badla transactions, futures/
forward, call and put options, interest
rate/currency swaps, partially
convertible and fully convertible
debentures are important financial
innovations that have taken place in
Indian financial system. There were
various types of motivating factors
behind these innovations like tax
benefit, volatility of share prices, R.B.I.
restrictions and pricing and interest rate
regulation, transaction and agency cost
etc.
Conclusion
Financial engineering is the
application of investment technology
in an effort to solve financial problems.
Financial engineers are employed by
investment banks, commercial banks, a
variety of other intermediaries and non
- financial corporations. Financial
engineers are responsible for most
614

financial innovations. Financial


engineers must be trained in conceptual
theories like valuation theory, portfolio
theory, accounting relationships and in
the physical tools that take the form of
financial instruments and processes.
Financial engineers work as a part of
team work. The elements of the team
will vary depending on the nature of
engineering involved. Member of team
might include accountants, tax
specialists, attorneys, underwriters,
capital market personnel, financial
analysts, programmers and so on. All
members of the team are carefully
selected to work together efficiently and
with the speed required by the situation.
Thus, various financial engineering
activities are playing a significant role
in the global markets.
Bibliography
l Finnerty, J.D.; Financial engineering

in corporate finance: An overview,


Financial management, winter, 1998.
l Marshall, John and Bansal, Vipul.K,
Financial Engineering: A complete
guide to Financial I1movations,
Prentic - Hall of India, New Delhi,
1996.
l James C. Van Horn, Financial
Management Policy, Pearson
Education, 2nd Edition.
l Kishore, Ravi M., "Management

Accounting and Financial


Analysis", Taxman Allied Services
(P.) Ltd., New Delhi, Second Edition,
2004.
l Kevin, S., Security Analysis and

Portfolio Management, Prentice Hall of India, New Delhi, 2007.


l Khan, M.Y., Indian Financial

System, Tata Mc.Graw Hill, New


Delhi.q

the management accountant, August, 2009

Cover Feature

Requirement of Balancing
between capital structure
and assets structure
leverages analysis
Susanta Kanrar*

everage : Leverage indicate


something by using of which
we can done very hard work
with very low effort. So by using
leverage effort can reduced. The
dictionary meaning of "Lever" is " A
bar for raising a weight ". Leverage
indicate the firm's ability to employ fixed
cost assets or fixed cost bearing funds
to magnify the rate of return to its owner.
In business world leverage is a very
common term. Ever business firm is
require take risk to get the return. Some
risk are controllable and some are
uncontrollable . we know the higher risk
provides higher return, so every firm
require to take at least some risk. This
risk taking capacity vary from business
to business and risk depends upon
some internal (controllable) and some
external (uncontrollable) factors.
In very simple word leverage
indicate effect of one financial variable
over the another related financial
variable. Normally one is dependent
variable and another is independent
variable. As sales is related with
advertisement expenditure. Generally
with the increasing of advertisement
expenditure sales go to increases
*M.Com, AICWAI, Asst. Professor &
HOD of MBA Department , Seacom
Engineering College, Dhulagarah, Howrah.
&
Visiting Professor, Seth Anandram Jaipuria
College, Kolkata.

,subject to all other market conditions.


By using the leverage we can measure
how much sales will be change for every
one rupee change in advertisement
expenditure, although it will be
anticipated value that can be differ from
actual value but by using the leverage
we can done it. For e.g if initial
advertisement expenditure is Rs.5,000
and sales is Rs.50,000 and if we increase
advertisement expenditure to Rs.6,000
and for this effect if sales increase to
Rs.80,000, the leverage will be :
% change in sales
(dependent variable )
Leverage =
% change in advertisement expenditure
( independent variable)
Rs.30,000
x100
Rs.50,000
Rs.1,000
x100
Rs.5,000
=3
This indicate that if advertisement
expenditure is change by 10% (positive
or negative) sales will also be change in
same direction by 30% (3x10 %) .
Leverage are of mainly two types,
namely :
i) Operating leverage and
ii) Financial leverage
There are also another type of
leverage which is admixture of this two

the management accountant, August, 2009

types of leverage called Combined


leverage.
Concept of Operating Leverage or
degree of operating leverage(DOL) :
Operating leverage measure the
business risk of the firm . Business risk
indicate uncontrollable and not easily
controllable risk. It may be externally or
internally generated. Risk arises from
change in demand, change in input
prices, change in Government policies
are example of external risk and on the
other hand risk from installation of high
plant capacity rather than actual need,
employment of excess salaried
employees are example of internal risk.
DOL express the relationship
between operating profit (EBIT) and
sales. It shows how much operating
profit will be change for every one
percent change in sales volume. For
example if operating leverage is 3 ,it
indicate that for every 1% change in
sales volume there will be 3% change in
operating profit.
It measure by the following formula:
% change in EBIT or operating profit
DOL =
% change in sales
Contribution
(S - V) Q
Or,
OR,
EBIT
(S - V) Q - F
Where , S= Sale price per unit
V= Variable cost per unit
Q = Number of units sold
F = Fixed operating cost
Higher DOL indicates higher
business risk. It is mentionable in this
respect that business risk is not easily
controllable . If the firm's operating fixed
cost is high then its DOL will also be
high. Generally DOL is more than one
or less than one but it never one , as
one is only possible when operating
fixed cost is nil, but it is not feasible in
actual practice. DOL became undefined
if fixed cost equal to contribution i,e at
operating break even level. DOL is
reciprocal of margin of safety . Margin
615

Cover Feature

of - safety indicate the excess of sales


over the break even point sales.

EBIT increases with multiple rate.


EBIT

process normally has high DOL


compare to lab our intensive
production process where DOL
value is low.

EBIT Curve

i,e
margin of safety
So high margin of safety indicate low
DOL,
Effect of DOL can be understood from
the following example :
Current sales
Rs.2,00,000
Variable cost
50% of sales
Operating fixed cost
Rs.50,000
If sales change by +/-- 10% then what
will be effect of DOL on operating profit.
Sales - variable cost
Current level of DOL =
(Sales - variable cost) - Fixed cost
Rs.(2,00,000 --- 1,00,000)
=
RS.( 2,00,000 - 1,00,000 ) -- Rs.50,000
=2
if sales change by + / -- 10%
In the above example DOL is 2 , for
this reason change in operating profit
is 20% due to change in sales by 10%
i,e (2x10%=20%).
Relationship between fixed cost and
degree of operating leverage can be
shown as below :

Degree of
Operating
Leverage(DOL)

DOL

O
Quantum of fixed cost
In the above diagram with the
increasing of fixed cost DOL is also
going to increases, as per the
relationship between fixed cost and
DOL.
In the same way relationship
between sales and EBIT can be shown
below :
EBIT can negative ,zero or positive
but with the increasing of sales volume
EBIT go to increases. EBIT curve is more
steeper as with the increasing of sales

Concept of financial leverage or Degree


of financial leverage:

Sales
Features of DOL:
v Value of DOL is always more than
v
v
v
v
v
v

616

fixed cost go to reduced.


v Capital intensive production

one or less than one but never one.


It express the relationship between
sales and operating profit .
DOL value depends upon
company's assets structure.
DOL value is unique for each level
of operation.
It is undefined at operating break
even point.
DOL is less controllable compare to
financial leverage.
High DOL indicate low margin ofsafety , as they have inverse
relationship.
High fixed cost oriented industries
like steel, airlines, railways, cement
has high DOL where low fixed cost
oriented industries has low DOL,
like retailing, paper industry, textile,
Bidi etc.
With the increasing of sales DOL
value tends to one. This is because
with the increasing of sales per unit

Particulars

Financial leverage express the


relationship between earning per share
(EPS) and earning before interest and
taxes. It indicate the firm's ability to
use/employ fixed charges bearing funds
to magnify the rate of return to its owner.
It depends upon the nature of
company's capital structure. By using
the Concept of financial leverage or
Degree of financial leverage (DFL) we
can measure the sensitivity of EPS due
to any change in EBIT. It totally
depends upon quantum of fixed
charges bearing funds like debenture
capital, preference share capital and
other long-term debt capital. etc. with
the increasing of fixed charges bearing
funds , the degree of financial leverage
also go to increases. If fixed charges
bearing funds is nil, then DFL will also
be nil. So proper capital structure
planning is must to keep DFL within
desirable limit by taking internal and
external various factors. Internal factors
like estimated cash flow statements for

Current level sales


Rs.
2,00,000

+ 10 %
Rs.
2,20,000

10 %
Rs.
1,80,000

Variable cost

1,00,000

1,10,000

90,000

Contribution

1,00,000

1,10,000

90,000

50,000

50,000

50,000

50,000

60,000

40,000

+ 20 %

20 %

Sales

Less : Fixed cost


Earning before interest
And taxes
(EBIT)
% of operating profit
changes from current
operating profit level

the management accountant, August, 2009

Cover Feature

next five to ten years, EBIT-EPS


analysis, DOL position etc. External
factors like near future market position,
government norms relating to debtequity mix, availability of debt fund at
reasonable cost etc.
Degree of financial leverage (DFL)
is measured by the following formula :
% change in EPS
DFL =
% change in EBIT
EBIT
OR,
EBIT - I
(S-V)Q-F
OR,
( S - V ) Q - F - I where,
S = sale price per unit
V = variable cost per unit
Q = quantity sold / number of units sold
F = Fixed operating cost
I = Fixed financial charges
DFL depends upon fixed financial
charges and fixed financial charges is
totally controllable , so DFL is also
controllable . For this reason DFL can
be less than one, one or more than one
.If DFL is three, then it indicate that for
every 1% change in EBIT there will be
3% change in EPS. DFL is reciprocal of
financial break even point , financial
break even point is the point at where
EPS is nil.
The main object of using debt
capital (fixed charges bearing funds) is
to multiply the rate of return to equity
shareholders/ owner. So it is always
desirable to use debt capital to some
extent if market in booming / growing/
stable stage , otherwise it is not possible
to increase the rate of return to equity
capital / owner. The basic reason
beyond this that fixed financial charges
is fixed irrespective of the firm's income
level. It always go in favor if actual rate
of return on capital is higher than the
interest rate or preference dividend rate.
But at the same time it is also risk able if
firm is not able to earn more than the

cost of debt capital. There are no legal


compulsion to pay preference dividend
in regular way if company not in a
position to earn profit, except
cumulative preference share whose
arrears preference dividend are
accumulate in loss year and company
require to pay this arrears dividend in
profit year .
Relationship between capital
structure and EPS can be clear from the
following example :
So from the above example it is
noticeable that even employing same
amount of capital and earning same
amount of EBIT firm can increase its
EPS by planning its capital structure in
proper way. So introduction of some
debt capital in capital structure helps
to earn higher EPS.
If in the same example EBIT change
by 20% in case of firm-B what will be
impact on EPS (firm - A is a nil geared
firm so there will be no impact on EPS
due to any change in EBIT )
Capital structure

EBIT
Current DFL of firm B =
EBIT - I
Rs 2,000
=
Rs. (2000 - 400)
=
1.25
Graphically relationship between
financial leverage and fixed charges
bearing funds can be shown below :
DFL

DFL
C'
B'
A'
O

Fixed charges bearing funds


From the above graph it is clear that
with the increasing of fixed charges
bearing funds DFL is also going to
increases.
ABC Ltd
Rs.

MPQ Ltd
Rs.

1,000 Equity shares of Rs.10 each

10,000

500 Equity shares of Rs.10 each


8% Debenture

10,000

5,000
5,000
10,000

EBIT

2,000

2,000

Tax rate

40%

40%

EBIT
Less : Interest

2,000

2,000
400

EBT

2,000

1,600

800

640

1,200

960

Compute EPS
Ans.

Less: Tax @40%


Earning after Tax (EAT) (A)
Number of Equity shares (B)
Earning per share (EPS) ( A / B )
Higher EPS in MPQ Ltd
Due to proper capital structure

the management accountant, August, 2009

1,000

500

Rs.1.20

Rs. 1.92

Rs.(1.92---1.20)
Rs.1.20
=60%
617

Cover Feature

Particulars

Current level sales

+ 20 %

20 %

Rs.

Rs.

Rs.

2,000

2,400

1,600

400

400

400

1,600

2,000

1,200

640
960

800
1,200

480
720

EBIT
Less : Interest
EBT
less : Tax ( 40% )
Earning After Tax
(EAT)
Number of Equity shares
EPS
% change

500

500

500

Rs. 1.92

Rs. 2.40

Rs. 1.44

+ 25%25%
( 1.25 x 20%)

As OC>OB>OA (i,e fixed charges


bearing funds) so CC'>BB'>AA' i,e DFL.
At point 'O' fixed charges bearing
funds is nil so DFL is also nil.
In the same way relationship
between EBIT and EPS can shown :

EPS
C'
EPS

B'
A'
O

X
EBIT
At point 'O' EBIT is nil , so EPS is also
nil. With the increasing of EBIT, EPS is
going to increases as evident from the
diagram. Here OC>OB>OA (EBIT) ,for
this reason CC'>BB'>AA' (EPS). The
rate of increasing of EPS is more higher
than the increasing rate of EBIT due to
multiple effect of DFL . For this reason
OK line (EPS line) is more steeper than
DFL line.
Some features of DFL :
v DFL depends upon company's
capital structure.
v DFL may be less than one , one or
more than one.
v It depicts the relationship between
EBIT and EPS
v With the increasing of fixed charges
618

( 1.25 x20%)

bearing funds DFL is also going to


increase and Vice-Versa.
v DFL is the reciprocal of financial
break-even point.
v Financial leverage is totally
avoidable but not desirable.
v In case of simple capital structure
DFL is one but it is more than one
for complex capital structure.
v DFL has the multiple effects on the
EPS due to any change in EBIT level.
Concept of combined leverage :
Degree of operating leverage (DOL)

reflects the sensitivity of operating profit


due to any change in sales volume. It
measure the operating risk of the firm.
on the other hand degree of financial
leverage shows the responsiveness of
earning per share (EPS) due to any
change in operating profit. It measure
the financial risk of the firm.
Degree of combined leverage (DCL)
reflects the combined effects of
operating leverage and financial
leverage. We know the firm has mainly
two types of risk viz operating and
financial risk. So combined leverage
measure the total risk of the firm. It has
the multiple effects of DOL and DFL.
DCL shows the direct relationship
between EPS and sales volume. For
example if DCL is four , it indicate that
for ever 1% change in sales volume
there will be 4% change in EPS. It is due
to the multiple effects of DOL and DFL.
It is measure by the following
formula :
As DCL measure the total risk of the
firm , so it should be planned very
carefully. If the firm has high DOL,then
firm should go for low DFL. So that
overall multiple effects remain within the
control. On the other hand if firm has

DCL = DOL x DFL


% change in operating profit
Or, DCL =

% change in EPS
X

% change in sales volume


% change in EPS

% change in operating profit

Or, DCL =
% change in sales
Contribution
Or, DCL =
EBT
Q( S - V)
Or, DCL =
Q ( S - V ) - F - I -- ( preference dividend / 1 - T)
Where ,
Q = sales quantity
S = sale price per unit
V = variable cost per unit
F = fixed operating cost
I = interest cost
T = tax rate applicable to company
the management accountant, August, 2009

Cover Feature

low DOL, then firm can opts for high


DFL.
Leverage plan should start from
operating leverage and ends to financial
leverage. Operating leverage is the base
built , depends upon financial plan
should done . Operating leverage is less
controllable whereas financial leverage
is totally controllable. If firm not desire
high DFL then can pay debt capital and
redeemed preference capital to reduce
DFL. But it is not possible in case of
DOL.
The relationship between EPS and
sales volume can graphically shown as
given below :
EPS

Y
S
EPS
P

S
P
Sales

In the above diagram OS>OP (Sales


volume ) for this SS'>PP' (EPS). In the
graph HS'> PS i,e rate of increasing of
EPS is higher than than the rate of
increasing of sales . This is due to
multiple effect of DCL.
Features of DCL :
v It shows the relationship between
EPS and sales.
v DCL can less than, equal or more

than one.
v High DCL indicate high total risk of

the firm and vice- versa.


v It exhibit the multiple effects of DOL
and DFL.
Leverage Analysis of Hero Honda
Motors Ltd (HHML) And Bajaj Auto :
Hero Honda Motors Ltd :
Hero Honda Motors Ltd (HHML),
established in 1984, is a joint venture
between Hero Group, the world's largest

bicycle manufacturers and the Honda is the largest selling motorcycle in the
Motor Company of Japan. Today it is country.
the world's largest two-wheeler Table: Market share in motorcycles
manufacturer. Hero Group belongs to
(%)
FY04
FY03
the Munjal family and came into
HHML
48
44
existence in 1956. It manufactured
Bajaj
Auto
24
24
bicycle components in the early 1940's
TVS
Motor
16
18
and later became the world's largest
bicycle manufacturer.
Yamaha
06
08
Others
06
06
HHML manufactures a range of
motorcycles with brands like CD Dawn,
Splendor, Passion, CBZ, Karizma and Bajaj Auto Ltd :
Bajaj Auto Ltd (BAL) is the second
Ambition. It is the market leader in twowheelers and its Splendor range of bikes largest two-wheeler maker in India. It
Income statement
Period to
FY02
FY03
FY04
(Rs in mn)
(12)
(12)
(12)
PBIDT
7,469
9,497
11,475
Interest
(15)
(17)
(17)
Depreciation
(510)
(634)
(733)
Profit before tax (PBT)
6,944
8,846
10,725
Tax
(2,315)
(3,038)
(3,441)
Profit after tax (PAT)
4,629
5,808
7,283
EPS (Rs)
23.2
29.1
36.5
DFL = PBIT/PBT
6,944+15
8,846 +17
10,725+17
6 ,944
8,846
10,725
=
1.002
1.002
1.002
DOL = PBIT+DEPRECIATION / PBIT
6,959+510 8,863+634 10,742+733
6,959
8,863
10,742
=
1.073
1.072
1.068
DCL = DOL X DFL
1.075
1.074
1.070
Income Statement
Period to
FY02
FY03
FY04
(Rs mn)
(12)
(12)
(12)
PBIDT
7,708
10,070
12,063
Interest
(34)
(11)
(9)
Depreciation
(1,797)
(1,712)
(1,799)
Profit before tax (PBT)
5,878
8,347
10,255
Tax
(1,837)
(2,502)
(2,191)
Profit after tax (PAT)
4,041
5,845
8,064
EPS (Rs)
51.2
52.8
73.0
DFL = PBIT/PBT
5,878+34
8,347 +11
10,255+9
5,878
8,347
10,255
=
1.006
1.001
1.001
DOL = PBIT+DEPRECIATION / PBIT 5,912+ 1,797 8,358+1,712 10,264+ 1,799
5,912
8,358
10,264
=
1.304
1.205
1.175
DCL = DOL X DFL
1.312
1.206
1.176
Contd. on Page 623

the management accountant, August, 2009

619

Cover Feature

My Experiment with
Inventory Management
T. Renganathan

rofessionals acquire their


knowledge through their formal
education but sharpen them
through the following methods:
i) Continuing education
ii) Making better use of exposure he
gets in place of work.
I had an opportunity to work for a
private Company in Bangkok
(Thailand).
Background:
The Company is a manufacturer of
Starch derivatives viz. Sorbitol,
Dextrose anhydrous Hydrate (DAH)
and Dextrose Mono hydrate (DMH).
The main raw material is Starch powder
produced from tapioca roots. Sorbitol
solution has wide use in tooth paste as
a sugar free sweetener. DAH has
Pharma use as preparing glucose saline
used in hospitals and DMH has wide
use in preparation of energetic health
drinks.
The manufacturing process is that
of continuous food processing
Industry wherein Starch Powder
dissolved in huge tanks goes through
various non stop processes and finally
packed in Drums (Sorbitol) & PE bags
The Company made an annual
Turnover of USD 15 million.
After I joined I was so depressed
when I found that environment was bit
hostile and accounts were in a mess . I
summoned up my courage and did extra
work to update tally accounting
package. Tally we all know is an
effective accounting tool. The mantra
is keeping data entry online. Never
forget to get debit and credits
accounted for the day and rest of it is
simple.
620

After this step, I ensured that


i) my cash is in place
ii) my BRS never gets postponed
I encountered a problem with my
receivables. The universal problem with
Receivables is lack of follow up in a
consistent manner. Tally gives bill wise
due dates. Down load these details for
bills falling due in the next 7/15 days
and confirm from the Customer when
the Cheques can be collected. In case
of troubled signals from client, take
proactive actions like
i) Stop further supplies
ii) Step up follow up for recovery.
This technique really worked.
Vital Link to Profitability Measurement
I was preparing the monthly
profitability statement and started
asking the question how accurate is my
profitability figure as this is the primary
performance Indicator for any
Organisation.
I looked at the sales figure and asked
am I accounting for all sales or left out
some thing?
I looked at material and stores
consumption data from Inventory deptt.
How correct is this??
I became restless I wanted to ensure
that I have a system to prove beyond
doubt these two figures are sacrosanct?
Stores as it meant nothing to many
people in the Organization including the
top management were found isolated
and located in remote corner. Though it
housed more than 2000 items, the
activity in stores were lull and dull It
was looking like a place where every
thing can be taken for granted like any
one can get into stores any time, take
away any thing . No body knows if the
organization really needed to store 2000

items in stock for their operations.


"Store Keeping is Defined as a Place
for Everything and every thing in its
Place"
Stores are of two types - i) raw
material and spares ii) finished goods.
Phase -1
We will discuss in this phase Stores
for Raw material & spares
Stores were taken seriously by the
Operating people for wrong reasons /
practices.
i) to blame stores for breakdowns for
not keeping some items like bearing
etc. which is not even any time
indented by him for purchase.
ii) barging into stores with gang of
workers during lean hours and
frisking away with valuable
materials(in the name of urgency)
without even throwing an issue slip
iii) Management often contributed to
poor stores management as they
possibly perceived that stores
make no contribution to value
chain and therefore they tend to
ignore stores by
a) not empowering stores in-charge in
regard to controlling movement of
goods and men in and out of stores
b) not ensuring that proper stores
accounting (by providing
Appropriate Software) is in place
c) not adequately equipping stores
with gadgets and material handling
devices.
What if store is not managed properly?
1) It becomes a place for miscreants
in the organization to dump items
and spares which will never be
used.
2) Materials will be stored in an
improper manner that access and
retrieval will lead to wastages /
deterioration in the quality of
stocks.
3) Genuine break downs (not
orchestrated ones ) due to absence

the management accountant, August, 2009

Cover Feature

of physical counts and reporting


of improper stock
4) Under /over stocking of inventory
leading to very poor working capital
management.
5) A loosely organised Store leads to
in accurate measurement of
consumption of critical inputs like
raw materials. This is having a
serious impact on measuring the
actual consumption of these items
against Internal Standards as well
as Industry Stds. (Obviously a
flawed store accounting system will
leave the top brass guessing about
their efficiency compared to their
competitors). A loose store (??) can
again become an excuse for
Operating guys to get away with
their lapses for they can challenge
information produced by Stores.
6) Incorrect reporting of value of
material consumption and value of
stocks at the end of a period leads
to substantial flaw in profitability
reporting. If Profitability count is
to be considered as the basic
indicator of well being of the
concern, an Improper Stores
accounting can fail the entire
organization.
Some one in my finance team
decided to move my office to a store
which was so far considered
untouchable. I also felt that some one
is degrading my position and finally
agreed in a half hearted manner.
The Process
I kept thinking what I can do to make
a difference in stores. I had a very
valuable assistant in stores. The ABC
method of Inventory Control did a flash
in my mind. Next day I took list of major
Raw material and Packing material which
was hardly 20 in number but accounted
for 70% of total cost for the Organisation
After some time, every day first
ITEM
NAME

OPENING
STOCK

RECEIPTS

thing in the morning we took a physical


count of (nearly) all these items. We put
these 20 items in a single page Excel
sheet. We monitored entry by entry the
receipts and issues of these 20 nos .and
arrived at book stock before we proceed
for physical count. As these were bulk
items and we were counting these
stocks on a daily basis, we had mastered
method of physical count of these items
in a quick and easy way.
The excel sheet mentioned was
formatted as below:
Min./max stock Levels defined for
each item will trigger the Indent quantity
to be purchased.
This one page excel report (Daily
stock Report) sent to Purchase deptt.on
a daily basis
Created a sort of history to say that
there was no complaint in the last 5
years that production got affected
because particular item of raw
material or Packing material was not
available.
Min, Max and re-order levels were
defined in this report and stocks
were managed within these levels an approach towards Just in time
Inventory(JIT)
Items in stock were always the latest
receipts as stocks were replenished
at short intervals (7 days to one
month)
We had also introduced by the same
time new software for stores accounting.
The daily stock report as above became
a cross check to verify correctness of
entries in the system in regard to
receipts, issues and stock. As a result
we were doubly sure of Consumption
value reported at the end of the month.
While we achieved our objective of
controlling stocks and reporting
accurate consumption value in regard
to "A" category items as above, we

ISSSUES

the management accountant, August, 2009

CLOSING
STOCK

MINIMUM
LEVEL

started thinking towards rest of the


items. There were about 2000 items still
in stock. (B and C category)
We classified these items into the
following category1) Insurance spares Spare-parts for machinery kept in
stock as they are ordered for stock for
emergency break down or accompany
the Original equipment. - Stores have
no control over these stocks but we felt
that stores had a responsibility to verify
these stocks at regular intervals and
report on the same through a special
report as below:
High value stock reports:- There is
a monthly report on high value
insurance spares ( showing, apart from
qty and value, no of days in
stock(ageing), condition of the material
etc. This in my opinion is a very
valuable 2-3 pages report because it
picturises the entire store to the user
and all details he can ask for regarding
these items without he actually having
to inspect stores. Also it is great check
on theft or pilferage.
2) Regular and non regular items:
Remaining items in stores other than
Insurance spares and raw materials had
to be classified as regular items and
other non regular items not only for
control purposes but also for fixing
responsibility for indenting of these
items and consuming the same.
Regular items were defined as items
which were issued at least 2-3 times in
the last 6 months and are capable of
repeating consumption pattern in the
future. Minimum and maximum stock
levels of these items were fixed based
on last 6 months usage. Stores took the
responsibility to indent for these items
as their stock reached the Minimum
level. We used the stores software to
automatically generate indents for
regular items.

MAXIMUM
LEVEL

RE-ORDER
QUANTITY

REMARKS

621

Cover Feature

Auto indents were yet another


milestone in stores operation. Store
is responsible for maintaining stocks
of regular items. Auto indents were
generated
thro
Computer
Programming whereby indents were
automatically raised by the system
as and when actual stock for an item
was reduced below Min. stock.
Manual intervention was totally
avoided by this process.
Now it is very clear that non regular
items (items that were not found any
usage in the last 6 months) clearly are
one time usages and it is the
responsibility of user deptt. to indent
for the same. Store will act as a watch
dog and ensure that non regular items
ordered for are consumed as and when
they are received. Stocking of Non
regular items was not permitted unless
it is ordered as a Desirable item to be
kept in stock.
We had a separate bay for keeping
the Non Regular items and we put a
sticker on it with date of receipt so that
by a mere visual examination it can be
seen that these items are removed for
consumption within a reasonable period
as they are received.
As it can be seen that essence of
stores accounting consists of the
following processes:
1) On line accounting of receipts and
issues
2) Regular and consistent physical
verification and sorting out
differences.
With availability of special soft ware
for store accounting and LAN
connectivity, the job is made easy but
the same had to be aligned to local
requirements and certain techniques
have to be innovated like the following:
i) I was very adamant that issue
requisition slips should be punched
outside stores by User himself and issue
622

updated real time when material is issued


by stores. Manual issue slips are not
used. This means online receipts and
issues and on line stock information.
Another milestone, ensuring up-to-date
stocks, issue reports being produced
promptly and accurate information as
the inputs are directly checked by user.
ii) We introduced a night shift for
stores and store attendant will take care
of emergency night issues and also
physically verify B&C items from a list
of 100 odd items printed from the system
every day. Selected items from the list
will be verified again in the morning to
ensure that Stock-count assistant
remains alert and his physical count can
be relied upon. Thus each item in the
store got verified at least once in a
month and verified not less than 12
times in a year.
As we all know physical verification
that is a laborious and tedious affair got
reduced into a simple routine. The
benefits were immense particularly it
helped Break down Management
system, as spare parts as reported in
the system are now available.
The Results
The real benefits of simple and
efficient store accounting system were
reaped in the following areas:
1) Accurate measurement of critical
inputs (Raw material and Packing
materials) consumption. This helped
us to establish actual consumption
of these items per ton of output
(Production).
This
actual
consumption (which is a un
disputable figure now) when
compared with Std.norms if found
to be not within the acceptable
range triggered an internal checking
to bring out any abnormality in any
of the sub processes. This process
abnormality was earlier went
Unreported.

2) To drive the message that store is


NOT a dumping yard and it is a
transit point in the production
process. Materials brought in have
to be issued swiftly and consumed
for the indented purpose.
3) Apart from A category issues,
materials were issued for
maintenance of machinery and plant
.Stores system produced an
undisputable weekly report on the
maintenance expenses. This helped
us to control these expenses and set
realistic maintenance budgets.
4) Simple excel reports (monthly) on
insurance spares keep a track of
critical machinery spares and
Operating people dont have to visit
store every time to ascertain stock
and physical condition of these
items.
5) Very obvious advantage was to
reduce capital blocked in inventory
and accurate profitability reports
Phase -II
Now let us look at the other face of
Inventory, the finished goods - we had
three products Viz Sorbitol solution.
DAH (dextrose anhydrous) and DMH
(dextrose Mono hydrate)
Sorbitol was packed in drums and
others in PE bags
Issues involved here were
i) How to verify Production Nos.
ii) Stock reported at end of day.
Here again Brain storming helped:
We produced two stock reports
i) from accounts based on production
reports, sales invoices raised
ii) Prepared from warehouse based on
their production count, dispatches
effected.
The two reports were independently
prepared and matched on a daily basis.
The difference between the two quickly
highlighted the mistakes in Production

the management accountant, August, 2009

Cover Feature

reports, sales reports or data entry on


either side.
Here you can presume that half the
work has been done towards a perfect
physical count as clerical mistakes are
eliminated.
The ware house keeper now
assumes the responsibility for physical
stock as he counts production Nos.and
dispatches on a daily basis.
The ware house stock register is
organized in such manner both receipts
into ware house and issues from the
same are controlled by Production
designated Batch Nos. Hence it is
always easier to track which particular
batch is in stock at any point of time
and verify that they are in stock.
Obviously success here depends on
the consistency with which stocks are
verified at regular intervals. In addition
to physical verification by Warehouse

keeper on a perpetual basis, we had a


team to check the stocks on a quarterly
basis to ensure the system continue to
work
Conclusion
To conclude the above success in
Inventory Management is very simple
if the following rules are adhered to:
1) Store is not a place to be taken for
granted and it is nerve centre of both
production as well as financial
functions.
2) Entry and Exit of both material and
men should happen holistically.
3) Realise that Inventory Management
is a value adding activity by helping
Production management, Performance reporting ( measurement of
inputs and profitability) and
reduction of Inventory.
4) On line data entry by drivers of

activities (users) holds key to


efficiency in stores.
5) Perpetual physical count or
consistent periodical physical
verification process is necessary to
confirm reliability of the system.
6) Flexible and efficient stores
accounting software.
7) Maintain a two tier system where
ever possible to produce stock
reports so that one can act as a check
on the other.
8) A Simplified and innovative
approach all through the way.
In the end I would strongly suggest
that stores operation is organized under
the accounting chief as he is
responsible for producing Profitability
statement for the Organization and I
doubt any one can do this job properly
with neglecting to see Physical
arrangement in stores and ensuring a
proper accounting machinery.q

Contd. from Page 619


was established in 1945, as a trading
company and obtained a production
license in 1959.It initially struck a
technical collaboration with Piaggio of
Italy but later started selling products
under the Bajaj brand name.
BAL's product range includes Scooters
(geared and ungeared), motorcycles,
Step- throughs, three-wheelers and
spare parts. BAL has undergone a
change from being a predominant player
in scooters till 2000-01 to becoming the
second biggest manufacturer in
motorcycles that also produces scooters.
Bajaj Auto holdings is fully owned
subsidiary of BAL. Other associates
include Maharashtra scooters Ltd,
where it has a 24% stake, and Bajaj Auto
finance Ltd, 1where it has a 31.3% stake.
It has a presence in the insurance sector
too with its subsidiary Bajaj Allianz
general insurance company Ltd and
Allianz Bajaj life insurance company Ltd
with a 74%holding in each in a joint
venture with Allianz.

Comparison of leverages of two companies :


Hero Honda Motors Ltd

Bajaj Auto Ltd

FY02

FY03

FY04

FY02

FY03

FY04

DOL

1.073

1.072

1.068

1.304

1.205

1.175

DFL

1.002

1.002

1.002

1.006

1.001

1.001

DCL

1.075

1.074

1.070

1.312

1.206

1.176

Suggestion for further reading :


1. Financial Management ---- IM Pandey , vikas publishing house pvt ltd.
2. Financial Management --- Srivastava & misra, oxford university press.
3. Financial Management --- A.N Sridhar, SPD
4. Financial Management --- Ravi M.Kishore, Taxmann.
5. Financial Management --- Satish M. Inamdar. Everest Publishing House.
6. Financial Management --- CA . C. Ramagopal, New Age International publisher
7. Financial Management --- Paresh p.shah, biztantra.
8. Financial policy and management accountinf ---B. Banerjee. PHI
9. Financial Management --- Khan & Jain ,TMG
10. Financial Management - Kulkarni & Satyaprasad
Note : sources : india infoline.com for
data relating to Hero Honda Motors and
Bajaj Auto Ltd. calculation is made on
the basis of available break up of data.

the management accountant, August, 2009

More accurate calculation is possible if


details data are available. Author is no
way responsible if there are any errors
in data.q
623

Cover Feature

The New Age Financial


Reporting System-An
Overview of Extensible
Business Reporting
Language (XBRL)
Anupam Karmakar*
Abhijit Karmakar**
XBRL (Extensible Business Reporting Language) is the financial reporting for
the 21st century. It is a language for electronic communication of various business
data. With XBRL, a company can exchange financial data with other companies
in near real time basis. It improves the credibility of financial statements by
providing more transparent financial information. Cost effectiveness can also
be achieved under XBRL. Initiatives have been taken through out the world by
different organizations (including accounting bodies, world's leading
companies) to develop and implement XBRL. In this paper an attempt has been
made to provide an overview of XBRL.
Introduction
BRL (Extensible Business
Reporting Language) is an
open, freely available electronic
language to report and present financial
information. It is one of the important
issues in the present reporting practices
of financial information through the
globe. XBRL is a sub-set of XML
(Extensible Markup Language). As per
IASB (International Accounting
Standards Board), XBRL is a language
for the electronic communication of
business and financial data which is set
to revolutionize business reporting
around the world. It is a platform which
is independent, expandable and is a
standardized method of exchanging
information. XBRL helps to obtain more

*Faculty Member, Department of


Commerce (Day), S.A. Jaipuria College,
Kolkata.
**Faculty Member, Department of MBA,
Sikkim Manipal University, Kolkata.

624

accurate and transparent data in a faster


way as it provides a format which
enables greater reuse of reported
information. Thus XBRL enhances the
credibility of financial statements by
improving the transparency of reported
information. Using XBRL, information
can be disseminated in a flexible and
usable format on an almost real time
basis. Again cost-effective financial
reporting is possible under the XBRL
system. As XBRL provides some
unique opportunities to different
parties, more and more organizations
(including accounting organizations)
from around the world are increasingly
participating in XBRL initiatives. Now
more than 250 world's leading
organizations including Morgan
Stanley, Microsoft, and the major
accounting institutes take XBRL and
support it to develop the common
language for financial reporting. Again,
the US SEC has announced that it will
permit public companies to submit their

mandatory filings in XBRL format.


XBRL is a reporting format which
can be used to publish financial
reporting digitally. It improves the
consistency, accuracy and quality of
financial reporting as it can be used
independently or incorporated into
other computer applications which
require flexible informational sharing.
As an universal standard XBRL will
allow companies to integrate and
improve information sharing with
regulators, investors, accounting
institutions and bodies, government
agencies and other external entities. It
benefits all members of the business
information supply chain.
XBRL is a language for electronic
communication of various business
data. Each and every item is tagged with
information about various attributes.
XBRL tagged data can be read by any
software that includes an XBRL
processor and thus can be easily
transferred between computers.
Tagging data in XBRL format improves
transparency without additional
disclosures and again make more
information available to everyone.
In this background, this paper makes
an attempt to provide an overview of
the XBRL as the new age financial
reporting language. The rest of the
paper is organized as follows. Part-2
discusses the worldwide development
of XBRL. Part-3 is all about the process
of XBRL. In Part-4 the benefits and
problems associated with XBRL will be
found. XBRL is important in the Indian
context also. The developments that
have been taken place in India regarding
XBRL will be the matter of discussion
of Part-5. Part-6 discusses the future
application of XBRL. Part-7discusses
about the progression of IFRS-XBRL
convergence programme. The last part
(Part-8) concludes the discussion.
Worldwide Development of XBRL
XBRL was introduced in 1999 by the
XBRL International Inc. IT was
patronized by the AICPA (American

the management accountant, August, 2009

Cover Feature

Institute of Certified Public


Accountants). It has active chapters in
many countries including India. More
than 250 of the world's leading
organizations have accepted it. Major
applications of XBRL are developing in
Australia, Japan, Germany and the UK.
Besides AICPA, several professional
accountancy bodies from around the
world like, Canadian Institute of
Chartered Accountants (CICA),
Institute of Chartered Accountants of
New Zealand, Institute of Chartered
Accountants in Australia, Institute of
Chartered Accountants in England &
Wales (ICAEW), Institute of Chartered
Accountants in Ireland, Institute of
Management Accountants (IMA),
Institute of Certified Public
Accountants
in
Singapore,
International Accounting Standards
Board (IASB), and International
Federation of Accountants (IFAC) are
members of the XBRL International.
Taxonomy (a classification system for
business and financial reporting data
elements, again an extensible dictionary
or vocabulary of financial and business
terms) for financial reporting has also
been published by IASB for XBRL. This
taxonomy is an XML-based
specification for the 'Commercial and
Industrial' sector. It permits users and
suppliers of financial information to
exchange financial statements across all
software, technologies (including the
web), and the geographies. Regulatory
bodies in the US, Australia, Germany,
Japan, China, Denmark, Korea, the UK
and the Netherlands are implementing
XBRL. Due to XBRL implementation,
foreign capital investment has increased
significantly in the Korean Stock
Exchange. Argentina, Belgium, France,
Spain, Hong Kong, Italy and Ireland are
among other countries, which are also
using XBRL or have recently
announced projects to introduce it. The
major markets across Asia, Americas
and EU have started to adopt new
reporting standards including XBRL.
The software vendors are also

delivering XBRL enabled application to


the market around the world. Followings
are some of the worldwide
developments of XBRL:
I. Reuters released and published its
2001 full year end financial results
on the internet using XBRL. It was
the first publicly listed company in
the world to take this initiative.
II. Microsoft has become the first hightech company to publish its financial
statements on the internet in XBRL
format.
III. Bank of America and Deutsche Bank
announced to use XBRL in their
different banking operations.
IV. A draft of the new XBRL US GAAP
Taxonomies was released to the
public on 5th December 2007.
V. In May 2008, SEC (Securities and
Exchange Commission), US
announced its plans to require
companies to file their financial
results using XBRL computer tags.
Under this proposal about 500 of the
largest public companies would
begin filing their financial data in
XBRL, in early 2009. SEC expected
that most of the remaining
companies would also comply
within the following two years.
So, XBRL is already in use
internationally and as a new global open
standard for formatting financial
information, it is being embraced
worldwide by the business community.
Process of XBRL
XBRL is a XML based digital
language. It is a computer programming
add-on that tags on each segment of
computerized business information with
an identification code or marker. XBRL
is similar to a bar code for financial
statements. An electronically readable
tag (bar code) is put on each financial
statement element, which provides
additional context. The XBRL
technology would allow electronic
tagging of each individual item of data
(e.g. revenue, depreciation, fixed assets

the management accountant, August, 2009

etc.), instead of treating financial


information as a block of text; so that
computers can work on the information
using a set of rules. The electronic tags
are standardized and contain
taxonomies which are essentially the
dictionaries used by XBRL. Taxonomies,
which have been developed and are
maintained on the XBRL web site, define
the specific tags for individual items of
data. The tags are applied using a
tagging tool that retrieves the tags from
the standard taxonomies and applies
them to whatever format the financial
statements are created, such as
Microsoft Word or Excel. In most cases,
accounting software will insert the tags
automatically. Again tagged data can
be automatically retrieved and analyzed.
Tagged data can also be easily
transferred between computers.
In traditional financial reporting
system like spreadsheet representation,
the significance of the value depends
on its position. But in XBRL, the tagged
data item say "Payroll" would be
attached to the value. The XBRL tagged
data item indicates that it is independent
of its location in a spreadsheet,
database, or any other application. This
is so because XBRL enabled software
can locate and assemble the required
business data (textual, quantitative or
monetary) into a spreadsheet by
executing a simple command.
Under XBRL system, business
information is described irrespective of
the operating systems and computing
systems involved in the information
supply chain and in XBRL environment,
information can be exchanged with
greater speed, higher efficiency, and
enhanced reliability. XBRL can gather
and analyze business information as per
the needs of the users. This is possible
in XBRL with the help of two
instruments: (1) an instance document
(an electronic version of the XBRL
tagged business report) and (2) XBRL
taxonomy (an extensible dictionary or
vocabulary of financial and business
terms, as mentioned earlier).
625

Cover Feature

XBRL- Benefits and Problems


XBRL can be used as a cost
effective reporting system. It can save
time and money and facilitate
information analysis. On the other hand,
XBRL itself does not guarantee quality
financial reporting as its reporting
quality depends on quality information.
If information is not generated at all or
it is inadequate or misleading then
XBRL will not correct that problem. So
benefits and problems both are
associated with XBRL.
Benefits of XBRL:
XBRL system has a great
opportunity and potential to increase
the quality and usability of financial
reports and financial reporting
information. All users in the financial
information supply chain (e.g.
companies, the accounting bodies,
regulators, analysts, capital markets, the
government etc.) can be benefitted from
XBRL. Followings are the important
benefits:
I.

It is a cost effective system. Cost


effectiveness can be achieved by
improving the quality financial
reports and financial information
and by reduction in cost of
processing and disseminating
business information. Again under
XBRL system, once financial data
and information are created and
formatted for the first time, it never
has to be keyed in a second time or
reformatted for even special
presentations. Some studies found
that the application of XBRL can
lead to a reduction of more than
50% of the costs of traditional
reporting practices. Again, the
Gartner and Forrester analyst
reports suggested that the cost of
producing reports can be reduced
by as much as 70%.

II. XBRL significantly increases the


credibility of financial statements
by improving the transparency of
626

reported information. It is the ideal


tool to facilitate faster, more
transparent and more accessible
reporting.
III. XBRL provides more complete,
accurate and timely information in
the hands of management. Thus it
facilitates better decision making.
IV. 1XBRL is a reporting format which
publishes digital financial reports
as XBRL is based on internet
technologies. So searching of
specific data and information
related to a particular type of
analysis is also possible.
V. Under XBRL system, the speed of
handling of financial information
can be increased and the chance of
error (by permitting automatic
checking of data) can be reduced.
This system can easily handle data
in different languages and
accounting standards.
VI. XBRL can help the financial service
providers to collect and update
information about borrowers,
automate reports to regulators and
distribute or collect necessary
information related to loan portfolio
,sales and purchases.
VII. XBRL will help CAs (Chartered
Accountants)
and
CFAs
(Chartered Financial Analysts) to
provide valuable information and
knowledge on a real time basis.
Accountants and analysts can
expand their professional
opportunities and value in the
market place by using XBRL. In this

way XBRL will help the clients also.


VIII.XBRL reduces inconsistencies and
thus
enhances
investors'
confidence.
IX. XBRL allows regulators to validate
reported information prior to its
receipt and analysis.
X. As proper assessment is possible
on real time basis, risk is also
reduced under XBRL system.
XI. Mergers and acquisitions: In the
scoping and due diligence phases
of M&A activity, XBRL can be
used as a uniform means to gather
and compare information on target
companies, allowing management
to make better-informed decisions
and project pro forma performance
of the combined enterprise.
Following the closing of the
transaction and as integration takes
place, management and advisers
can use XBRL as an information
standard to improve access to data
held in different accounting
packages and elsewhere across the
new enterprise and to enable more
streamlined communication with
outside parties such as regulators,
tax authorities and investors.
Sarbanes-Oxley and similar
regulatory compliance - adhering to
the increasingly complex rules and
regulations for public companies can be facilitated by using XBRL
to move internal controls closer to
the actual data they are designed
to test. Also, using one core set of
reusable data that can be

Source: alastair.nimmons@ca.pwc.com

the management accountant, August, 2009

Cover Feature

repurposed for multiple reporting


audiences reduces the costs of
reporting.
XBRL can reduce or eliminate the
manual processes of entering company
results into financial models. This frees
up analysts to ask more searching
questions on earnings calls.
XII. Lower preparation cost
XIII. Reduced preparation time
VIV. Broader information availability
XV. Adaptability to changing
reporting requirements
XVI. Enhanced analytical capabilities
l Problems of XBRL:
It has already been mentioned that,
application of XBRL may create problem
at least at its implementation stage. The
benefits of XBRL primarily depends on
the accurate and timely availability of
information. Some potential problems
are as follows:
I. Primary cost of implementation is
relatively high.
II. Security may be an important factor
in data exchange through the
internet.
III. To understand XBRL format, proper
knowledge is required. Due to the
lack of knowledge, XBRL
implementation is tough in different
countries of the world.
IV. As XBRL is a standard, it has a finite
life span. It is affected due to
technological risk. XBRL may be
obsolete after certain time as a result
of innovation of new technology.
XBRL in Indian Context
Different initiatives have been taken
in the Indian context to apply XBRL.
EDIFAR (Electronic Data Information
Filing And Retrieval) system was
introduced by SEBI (Securities and
Exchange Board of India) in 2002. This
is an automated system for filing,
retrieval and dissemination of time
sensitive corporate information.
EDIFAR is modelled on the lines of
EDGAR (Electronic Data Gathering,
Analysis and Retrieval) system of the

US, and SEDAR (Systems for Electronic


Document Analysis and Retrieval) in
Canada, and is being hosted on the SEBI
web site. It is a repository of business
information for listed Indian companies.
SEBI in association with NIC (National
Informatics Center) has set up the
EDIFAR website to facilitate filing of
certain documents/statements by the
listed companies online on the web site.
This would involve electronic filing of
information in a standard format by the
companies. This system is useful for
various classes of market participants
including companies, investors,
regulatory organizations, research
institutions and the stock exchanges.
The primary objective of EDIFAR is to
centralize the information and accelerate
its dissemination. It enhances the
transparency and efficiency of financial
reporting for the benefit of all the
stakeholders in the securities market.
EDIFAR is being implemented in a
phased manner. All the listed companies
are required to file disclosure
statements and other information (filing
of the information in electronic format
was made compulsory by the market
regulator by amending the listing norms
of the exchange by inserting a clause to
the Listing Agreement) with the stock
exchanges where they are listed. The
stock exchanges disseminate this
information through trading terminals,
their website etc.
In the year 2005, Satyam Computer
Services Limited, a Hyderabad-based IT
services providing Indian company
announced that it has become India's
first direct participant member of the
XBRL International.
In January, 2007 The Institute of
Chartered Accountants of India (ICAI)
announced that, it would soon
constitute a committee consisting of
regulators to develop taxonomy for the
promotion of extensible business
reporting. Again in 2007, ICAI
constituted the XBRL Group for
undertaking the development and
promotion of XBRL in India.

the management accountant, August, 2009

In July, 2008 ICAI said it will come


out with the first part of a user-friendly
online language, XBRL by September
2008. A committee has also been setup
by the ICAI for looking at the various
aspects of XBRL and which is working
on its codification. The proposed
upgrading of MCA21 (a comprehensive
e-governance programme that has
already made the interaction between
companies and regulators much more
efficient) would make India the twelfth
country in the world to put corporate
financial information in the user-friendly
XBRL (as per the news published in The
Economic Times on 29 Aug, 2008). It
will allow hassle-free data mining and
effective utilization of data for research.
According to Ved Jain, the President,
ICAI, after placing of the language (i.e.
XBRL) properly one can easily
understand and harmonize the financial
statements. The development of general
purpose XBRL taxonomy is applicable
for commercial and industrial
companies. This taxonomy is based on
the requirements of the Indian
accounting standards and various
Indian corporate laws. Different
institutions (like SEBI, the Ministry of
Corporate Affairs, Reserve Bank of
India and the Insurance Regulatory and
Development Authority) are also
working with ICAI to develop that
general purpose XBRL taxonomy and
these institutions are supporting ICAI
in its XBRL development endeavors..
As per the future plan of ICAI, after the
development of general purpose
taxonomy, the institute would take up
the development of taxonomy for the
financial sector, specifically banks and
non-banking financial companies.
Recently, the Group has finalized the
draft general purpose financial reporting
XBRL taxonomy for commercial and
industrial companies. The draft
taxonomy covers the financial
statements, viz., Balance Sheet,
Statement of Profit and Loss, and Cash
Flow Statement and the related nonfinancial information. The draft
taxonomy has been developed
627

Cover Feature

conforming to Indian Accounting


Standards and Company Law while
adapting the architectural features of
the IFRS general purpose taxonomy
2006.
ICAI is also aiming to establish the
Indian jurisdiction of XBRL
international. It will encourage the
development and adoption of XBRL in
India and represent Indian interests at
the international level.
India's central bank, The Reserve
Bank of India also took initiatives to
develop XBRL. The Reserve Bank is
moving towards the XBRL standards
under a high level Steering Committee
chaired by the Deputy Governor, Shri V.
Leeladhar.
The Future Application of XBRL
XBRL provides an international
platform for a global economy. Thus it
has a great potential in future
application. By applying XBRL,
companies can be accessed
electronically
for
analysis,
benchmarking, reporting and financial
modeling. XBRL can also be applied for
cost accounting, performance
measurement, financial statement
analysis and decision making purposes
besides financial reporting. As the world
becomes more fast and complex, all the
information users in the financial
reporting supply chain are demanding
more extensive financial and nonfinancial information for more clarity.
Due to cross border transactions and
cross border capital flows, a sound,
transparent financial reporting system
(which is internationally accepted) is
needed to ensure global confidence in
the capital markets. Here lies the future
application of XBRL.
The use of XBRL will enable the
financial community to analyze financial
facts and figures as well as risk in a
better way. So from the capital market
perspective also, XBRL has immense
potentiality.
Other potential XBRL applications
include 'XBRL for Taxes', 'XBRL for
628

Regulatory Filings', 'XBRL for


Accounting and Business Reports' etc.
So the use of XBRL will become an
operational and financial reporting
necessity and not a luxury.
The 18th XBRL International
Conference will be held on October 1516, 2008 in Washington, DC. The
important topics to be discussed on
that conference are (1) the impact and
benefits of XBRL on institutional
investors, individual investors and
analysts, (2) impact of improved
reporting on proxies, ESG
(Environmental, Social and Corporate
Governance Factors) and corporate
social responsibility, (3) affects of XBRL
on grants reporting, tax, statistics,
municipals, budgeting and other agency
reporting etc. So we can expect some
good news about XBRL in the near
future.
Progression of IFRS - XBRL
Convergence Programme
On 24 July 2008 the Council of the
Institute of Chartered Accountants of
India decided to converge with IFRSs
for accounting periods beginning on or
after 1 April 2011. At the same time, the
key stakeholders in India are preparing
an application to XBRL International to
become a jurisdiction (XBRL India).
On 25 July 2008 the US SEC
published a Concept Release asking
investors, issuers, auditors and other
market participants to give their views
on the concept of US issuers using
IFRSs in preparing their financial
statements. A few weeks earlier of 25
July 2008, the US SEC published a
proposal to eliminate the current
requirement that foreign private issuers
filing their financial statements using
IFRSs must also file a reconciliation of
those financial statements to US GAAP.
Such information has to be linked with
the continuous US SEC interest to
XBRL.
Conclusions
Financial and business reporting is
a form of communication. It may be at
traditional form (like paper based

reporting) or digital form (like XBRL).


XBRL is a new and growing method for
representing business data digitally. It
is about enhanced distribution and rapid
analysis of business data. XBRL is the
world leader in converting financial
reporting data into digitally formatted
XML. An additional advantage of using
tagged data in reporting is that it greatly
simplifies the automatic validation of
data. Although there is risk associated
in adopting XBRL at present, but we
have to accept it for future benefits.
XBRL will provide competitive
advantages to business organizations
because it will create a revolution in
business world so far as financial
reporting is concerned. Again XBRL
has some specific and fundamental
characteristics, which provide strong
incentives to the market participants.
Financial reporting in the modern
corporate environment is becoming a
complex and ever-changing process.
High quality financial reporting is
essential and inevitable for transparent
business. To deal with the new business
of the 21st century effectively, more
accurate, transparent and an efficient
reporting system is necessary. XBRL
can serve that purpose. It provides
major benefits in the preparation,
analysis and communication of
business information. Even, XBRL can
be extended beyond financial reporting.
It can also be used to support the
corporate-wide knowledge management
process. XBRL is a big leap in
facilitating the intra and inter-corporate
communications process. Thus, XBRL
environment will provide a vast
opportunities for achieving higher
speed, greater efficiency, and enhanced
reliability in exchange of business
information (both financial and nonfinancial), and, benefiting decisionmaking by various user-groups (both
internal and external to an entity).That
is why XBRL is considered as the new
age financial reporting system and in
the future it will be the universal
language for financial reporting.q

the management accountant, August, 2009

Cover Feature

Shedding Newlight on
Standard Cost Variances:
Incorporating
Environmental
Considerations into
Product Mix Decisions
Ramamohana Rao Guttikonda*

s environmental issues
increasingly
influence
corporate performance they
need to be institutionalized in
management accounting systems!
Manufacturers need information from
their management accounting systems
for maximizing profit. Given
environmental spending a 1994 article
In management accounting by Jerry
Kreuze and Gali Newell supports the use
of activity based costing (ab in
conjunction with life-cycle costing for
allocating environmental costs to
products to get a handle on what those
costs are,2 their article illustrates the
implications on profitability analysis
from using the theoretically more
accurate ABC system to allocate
environmental cost to products that
generate those costs. The illustration,
however does not consider constraints
in the production process, so the
product mix decisions made from ABC
information may not facilitate product
maximization goals.
Two methods of evaluating product
mix decisions given an environmental
constraint include ABC and the theory
of constraints (TOC). While ABC is
important for understanding how
*Assistant Professor - Accounting Tuskegee
University, Tuskegee, Al

environmental spending affects product


cost, it does not necessarily help in
making decisions to reduce the most
environmentally damaging products
from the mix. Under certain conditions,
TOC may be the better choice for
maximizing profit while minimizing the
production of products causing the
most environmental damage.
Abc. Toc and Differing Assumptions
Both ABC and TOC appeared in
literature during the decade of the
1980s. Robin Cooper and Robert S.
Kaplan popularized ABC to trace costs
to products based on the way each
product uses resources. 3 ABC
recognizes that different products use
resources based on complexity rather
than on volume. Cooper and Kaplan
proposed using non-volume drivers to
allocate batch and product level costs
to units produced around the same time.
Eliyahu M. Goldratt promulgated TOC
to prioritize scheduling of products over
limited resources to maximize profit.4
Goldratt advocate eliminating all
allocations of any non-volume based
costs to units. The proponents of each
method believed their method ensured
that profit would increase more while
costs were being controlled. ABC
assumes that costs are predominantly
variable over the long run and that

the management accountant, August, 2009

variability should be recognized in all


decision-making. Cooper and Kaplan
traced the accelerated increase in fixed
costs over the decades in specific
companies belying their fixed cost
nature.5 They concluded that such
dramatic increase in fixed costs was
overlooked because managers assumed
that costs were fixed and did not need
to be monitored carefully only by
recognizing the True variability of
these costs would managers be
encouraged to monitor and limit their
proliferation. In contrast, TOC assumes
just the opposite, that most
manufacturing costs are predominantly
fixed with materials being the only
variable cost. Researchers Eric Noreen,
Debra Smith, and James T. Mackey
documented the way managers
controlled fixed costs even in the face
of increasing complexity, because they
believed these costs were truly fixed and
should not increase. 6 Therefore,
managers found ways to improve
processes and decrease non-value
added activities so these fixed costs
would remain constant. In addition, they
found, that in the face of increased
complexity, ABC-based companies had
increases in non volume-based costs
because the managers expected those
costs to increase.
A Different Focus
Another important difference
between TOC and ABC is focus. ABCs
focus is predominantly on cost and its
primary goal is to increase profit by
reducing cost via the reduction of
complexity. In the case of Pitney Bowes,
environmental operating and product
costs were reduced through the use of
ABC.7 TOC, on the other hand, focuses
rigidly on profit, and attempts to
maximize profits given a certain stable
level of capacity. To aid in the focus on
profit, TOC removes complexity, not
from the product, but from the allocation
process. 8 It only attaches volumedriven costs to each unit. The
assumption is that non-material costs
629

Cover Feature

are stable when used to produce several


products with shared resources.
ABC, on the other hand, seeks to
remove complexity from the system by
focusing on higher-volume products
using fewer resources for each unit
produced. What the ABC advocates
have tried to deal with was the quick
rise in indirect costs for both production
and non-production. In effect, ABC has
tried to become a method of doing
incremental analysis by highlighting
resource that will need to increase the
output of complex products. The
product mix that results will not
necessarily reduce the production and
sale of the product that pollutes the
most.
Focusing on the Constraint
A unique attribute of the TOC
method is the focus on the constraint
of the system. In order to increase profit,
TOC focuses on the use of limited
resources and recognizes that neither
unit cost nor unit-based profit is
sufficient to determine which products
Focus

should be produced. Instead, managers


must realize that every system has
constraints that limit profit. A constraint
can be external, such as the lack of the
demand in the market for the companys
products, but often the constraint is
internal to the company, such as limited
resource for environmental compliance.
When the constraint is an internal
resource, products using limited
amounts of the constrained resource or
products producing higher levels of
profit for each unit of the constrained
resource are preferred. In cases where
the constrained resource is used to
reduce pollutants, TOC helps to shift
the product mix to the product that
pollutes the least. Products requiring
more resources to reduce environmental
pollutants will be given lower priority
in the mix unless the prices charged to
consumers are sufficient to cover the
extra cost of eliminating those
pollutants.
Environmental Costs and Resources
Clearly, all businesses have an

impact on the natural environment from


the use of electricity and fuel, to paper
use and waste, to the more considerable
impacts
of
chemical-related
manufacturing both federal and state
governments regulate hazardous
material inputs and waste. Perhaps the
most onerous of these are the superfund regulations created to clean up
toxic waste sites and the resource
conservation and recovery act (RCRA)
for facilities that threat, store, and/or
dispose of hazardous waste. Beyond
hazardous
substances,
many
companies have chosen to adopt ecoefficient policies internally which has
the duel result of saving the companys
money as well as improving their
reputation with certain stakeholders.9
Internal environmental costs when
regulation are imposed may include
record keeping, reporting, labeling,
emissions and effluent management,
waste management, compliance,
training, research and development,
certification, and permitting. Typically,
costs may be diferentG depending on

Comparison of Abc and Toc


Abc Cost Control
Toc Profit Maximization

Method(s)

Reduce Activities
Simplify Processes
Reduce Product Offerings

Maximize utilization of the constraint


Simply Control
Eliminate non-value added activities/action

Treatment of Capacity

Identifies unused capacity if the


practical volume of the cost
driver is used to calculate rates

Focuses on the constraint, if internal by


maximizing profit over the constraint through
prioritization of production given throughout
(Amount needed per unit of the constraint)

If anticipated or normal capacity


volumes are used for the cost
driver rates, capacity is ignored
Cost Behavior Assumptions

All Costs are Variable

Most Costs are Fixed

Variable Cost

Unit, Batch, and Product-level


costs are variable
Allocating costs is the best way
to control the cost by
encouraging the reduction of
the cost to produce one unit

Most costs are fixed

Catalysts for
Cost Control

Viewing fixed costs in a lump sum and expensing


the cost in its entirety is a strong motivator to
control the cost

Timing of Expenses

Expense most production costs


when the unit is sold

Expense most production costs in the period


incurred

Items that Impact?

Sales and Production levels

Sales levels

630

the management accountant, August, 2009

Cover Feature

whether a company is generator/user,


transporter, or disposal facility for
hazardous materials. Table I includes
four categories of costs that were
derived under the assumption that the
company uses and generates
hazardous materials.
Comparing ABC and TOC
Green products, Inc. manufactures
four products. R, S,T, and U. Four
categories of environmental costs are
included in the array of manufacturing
costs in the company. Because
hazardous chemicals are used in the
manufacture of R, S, T and U. A
hazardous waste disposal fee per pound
is included which is assumed to be
variable. Green products invested in a
scrubber to clean emissions at the end
of the process, and the company incurs
environmental reporting (By Product)
and regulatory costs (By Facility). The
sales prices, materials costs, direct labor
usage, and resource usage of each of
the four products are listed in Table I.
Using ABC to Determine Product Mix
Using the demand levels in Table I,
the first step is to determine the load on
each resource to see if the current
demand can be filled. To see this, the
capacity used by each resource need
to be calculated and compared to the
capacity level available for each
resource. The calculations to determine
the demands on each resource are listed
in Table 2. As can be seen from the
calculations of machine hours needed
on each resource, only the
environmental scrubber needs more
time than 17 has available; therefore, not
all the products can be produced.
Management must determine which
product to emphasize and which defer
to last.
Prioritizing Production Using ABC
ABC is highly valued because of its
ability to trace the cost of activities to
products. In Table 1, a list of activities
and cost drivers is presented, using the
cost driver rates to attach the cost of

the activity to each product. The annual


amount of each driver listed in the table
is its practical capacity or the amount
of the cost driver possible if 100% the
resource is used, given real-world
efficiency for many companies. Practical
capacity is considered to be 855 of the
theoretical or ideal capacity- By using
practical capacity as the cost driver
level, several benefits occur. Allocated
unit costs are consistent for decision
making as long as costs for the
resources are unchanged. Available
capacity is highlighted on each
resource unavailable capacity is
highlighted on constrained resources.
Using ABC to determine the
product mix choice, contributions are
calculated for each product. For each
product-level cost, the amount of the
cost driver consumed by the product
was multiplied by the rate for the
product cost driver. The resulting
overhead was then traced to each
product line (see Table 3). Using ABC
to trace the costs to each unit, the
ranking for each product by profitability
from highe4st to lowest would be S, R,
T and U. with the order of production,
and given the limited time on the
environmental scrubber, S,R, and T are
produced to their demand levels and the
remaining time is used to make 1,000
units of U because of the decrease in
production of U from 8,000 units to 1,000
units, fewer of the unconstrained
resources are needed. Inventories in
this example are assumed to be zero, so
any un used capacity costs for any
activity are expensed as a period cost.
Based on the level of production and
sales, the profit for the company is
$1,020,000 (See Table 4).
Prioritizing Production Using Toc
The theory of constraints prioritizes
production based on throughput over
the constrained resource throughput in
TOC is defined as sales less the truly
variable costs (usually just materials).
Calculation of throughput per hour of
time on the environmental scrubber is

the management accountant, August, 2009

presented I Table 4. Using the


throughput per scrubber hour to
determine the order of production,
product R is the most profitable,
followed by S, U, and T respectively.
When production follows this order, all
of the units of demand for R, S, and U
are produced and sold; I the remaining
time. 10,500 units of Ts demand can be
satisfied (See Table 5).
Following this plan, the profit is
$1,695,00. This TOC-based profit is
$675,000 greater than the ABC-based
profit. Again the profit difference is
solely due to the focus of TOC vs ABC
on profit maximization vs cost incurred.
The profit calculations and the
differences in the product ranking and
in the profit generated by ABC and TOC
are presented in Tables 6 and 7.
TOC is always the best choice given
the following conditions:
1. Products are shared resources
2. Demand for all of the products
sharing those resources is greater
than the capacity of at least one
resource.
3. There is a commitment to maintain
capacity at the current level for the
immediate future.
4. There is a desire to maximize profit
over the current level of resources
5. When capacity increases are made,
the constrained resource is the first
resource purchased
6. The market dictates the price of the
competing products, and of those
prices or price and volume choices
are known before production plans
are solidified.
7. The creation of certain toxins is of
concern to the company, and there
is a desire to determine the product
mix that generates the fewest toxins.
Possible Ramifications for Green
Companies
By using TOC to identify the
constraint and to use it so that the
environmental scrubber was used most
profitably, the company simultaneously
chose product that used the least
631

Cover Feature

amount of scrubber time per unit. In


effect, the TOC method fostered the
selection of a theoretically cleaner
product than the previous mix because
it carried fewer toxin requiring scrubber
time. Product T needed 2 hours of
scrubber time while product U used

only 1 hour. In addition, the company


improved its own profitability.
It is also important to note that TOC
mix is chosen, there is unmet demand
(3,500 units) for product T in the market.
This means that the company has some
leeway for potentially increasing the

Table 1 Basic Product and Resource Information Green Products, Inc


A. Market Information
Products

Material A

Material B

$175

$250

$275

$350

Material C

20,000

12,000

14,000

8,000

Sales Price
Demand In Units

price of T to better reflect Ts environmental impact. This in turn could


increase profits even more. If companies
can reduce emissions while maximizing
profits, resistance to making environmental improvements should be more
tenable.
Material Pounds Per Unit

B. Materials Information - Unit Level


Price Per Pound
R

Materials

Price Per Pound

Material A

$10.00

$20.00 $40.00

Material B

20.00

20.00

Material C

25.00

Disposal of

7.00

Hazardous Material

21.00

20.00
35.00

$61.00 $95.00

$ 20.00
40.00
50.00

$150.00

42.00

42.00

$152.00

$192.00

C. Labor and Machine Information - Unit Level


Unit Driven
Resou rces/ Activities

Cost Driver

Annual Hours

Cost

Cost/Hours

Direct Labor

Labor Hours

30,000

$750,000

$25.00

Machine D

Machine Hours Available

20,000

250,000

12.50

Machine E

Machine Hours Available

30,000

400,000

13.30

Machine F

Machine Hours Available

40,000

600,000

15.00

Environmental Scrubber

Machine Hours Available

40,000

1,200,000

30.00

Machine Hours Per Unit


Labor Hours Per Unit
R

Direct Labor
0.50 0.25 0.75 0.50
Hours

Machine D

0.10

0.20

0.05

1.20

Machine E

0.05

0.50

0.30

1.80

Machine F

0.20

0.40

0.05

2.80

Environmental Scrubber

0.25

0.50

2.00

1.00

D. Batch - And Product - Level Costs


Cost Type

Annual Amount Possible

Material Handling
Environmental Reporting
632

Cost

Cost/Driver

# of Production orders 2,500

$75,000

$30

# of Products 4

150,000

37,500

the management accountant, August, 2009

Cover Feature

No. Of Orders And Product By Product Type

Orders
Products

R
750
1

S
500
1

T
200
1

Excess Deficiency
In Cost Driver

1,800
4

700
0

U
350
1

Table 2: Utilization Of Each Resource


The Environmenta Scrubber Is The Constrained Resource
Total Labor Hours
R
S
T
U Total
Excess
Deficiency
In Hours
Direct Labor
10,000 3,000 10,500 4,000 27,500
2,500
Hours

E. Facilities-level Cost
COST TYPE
Research and Development
Plant Maintenance
Building and Grounds
Environmental Regulatory Cost

Amount Needed

$500,000
200,000
625,000
250,000
$13,450.00

Machine Hours Per Unit

Machine D
Machine E
Machine F
Environmental Scrubber
R

Hours Needed

2,000
1,000
4,000
5,000

2,400
6,000
4,800
6,000

700
4,200
700
28,000

9,600
14,400
22,400
8,000

14,700
25,600
31,900
47,000

Excess Deficiency
In Hours
5,300
4,400
8,100
(7,000)

No. Of Orders And Product By Product Type


S
T
U
Amount Needed

Orders
750
500
Product
1
1
Table: 3 Example Of Product Ranking With Abc
Green Products Inc.
Sales
Unit Based Cost
MATERIALS
A
B
C
Disposal of Hazardous Material
Direct Labor
MACHINE COST
D
E
F
Environmental Scrubber
Total Unit Based Costs
Contribution Margin
Ranking Based on Contribution Margin
the management accountant, August, 2009

200
1

Excess Deficiency
in Cost Drive
700
0

350
1

1,800
4

Price Per Pound

R
$125.00

S
$250.00

T
$275.00

U
$350.00

$10.00
20.00
25.00
7.00

$20.00
20.00

$40.00
20.00

21.00
12.50

35.00
6.25

$20.00
40.00
50.00
42.00
18.75

$150.00
42.00
12.50

1.25
0.67
3.00
7.50
85.92
89.08
2

2.50
6.67
6.00
15.00
131.32
118.58
1

0.63
4.00
0.75
60.00
236.13
38.88
3

15.00
24.00
42.00
30.00
315.50
34.50
4
633

Cover Feature
Material Handling
Environmental Reporting
Product margin
Ranking Based on product margin
Demand in units
Production given demand and Scrubber constraints
Hours used for the Scrubber
Hours available in order of

1.13
1.50
86.46
2
20,000
20,000
5,000
29,000

1.25
2.50
114.83
1
12,000
12,000
6,000
34,000

0.43
2.14
36.30
3
14,000
14,000
28,000
1,000

1.31
3.20
29.40
4
8,000
1,000
1,000
0

Table 4: Profit When ABC Is Used To Determine Product Mix

Sales
Material
Disposal of Hazardous Material
Throughput
Direct Labor Cost
Machine Cost
D
E
F
Environmental Scrubber
Material Handling
Environmental Reporting
Product Margin
Research and Development
Plant Maintenance
Buildings and Grounds
Environmental Regulatory
Operating Income

$3,500,000
800,000
420,000
2,280,000
250,000

$3,000,000
720,000
420,000
1,860,000
75,000

$3,850,000
1,540,000
588,000
1,722,000
262,500

$3,500,000
150,000
42,000
158,000
12,500

25,000
18,400
60,000
150,000
22,600
30.000
1,729,000

30,000
80,040
72,000
180,000
15,000
30.000
1,377,960^

8,820
56,000
10,500
840,000
6,020
29.060
508,000

15,000
24,000
42,000
30,000
1,310
__ 3.750
29,440

Unused
Capacity
$10,700,000
3,210,000
1,470,000
26,020,000
150,000
171,250
226,667
415,500
30,150
30.000
1,023,56

Total
245,500,000
353,100,000
294,000,000
320,400,000
750,000,000
250,070,000
400,000,000
800,000,000
1,200,000
75,000

500,000
200,000
325,000
250,000
1,020,000

Table 5: Example of Product Ranking with TOC Green Products Inc.


Sales Price
Unit based cost materials price per pound
A
B
C
Disposal of Hazardous Material
Total Material
Throughput
Time on the Scrubber per Unit
Throughput/Scrubber Hour
Ranking
Demand In Units
Production Given Demand and Scrubber Constraints
Hours used for the Scrubber
Hours available in Order of Ranking
634

10.00
20.00
25.00
7
$114.00

R
$175.00

S
$250.00

T
U
$275.00 $350.00

20.00
20.00

21.00
$61.00
155.00
0.25
$456.00
1
20,000
20,000
5,000
35,000

40.00
20.00

35.00
95.00
123.00
0.50
310.00
2
12,000
12,000
6,000
29,000

20.00
40.00
50.00
42.00
152.00
158.00
2.00
61.50
4
14,000
10,500
21,000
0

150.00
42.00
192.00
1.00
158.00
3
8,000
8,000
8,000
21,000

the management accountant, August, 2009

Cover Feature

Table 6: Profit When TOC Is Used To Determine Product Mix


Sales
Material

TOTAL

$3,500,000

$3,000,000

$2,887,500

$2,800,000

$12,187,500

800,000

720,000

1,155,000

1,200,000

3,875,000

$2,280,000

$1,860,000

$1,291,000

$1,264,000

$ 6,695,000

Disposal of Hazardous material


Throughput
Direct labor cost

750,000

Machine cost
D

250,000

400,000

600,000

Environmental Scrubber

1,200,000

Material Handling

75,000

Environmental reporting

150,000

Research and Development

500,000

Plant maintenance

200,000

Building and Grounds

625,000

Environmental Regulatory

250.000

Total Operating Expense

5.000.000

Operating Income

$1,695,000

Table 7: Product Rankings and Profit Changes Using ABC and TOC
R

ABC Rank

TOC Rank

Product

TOC Profit

$1,695,500

ABC Profit

1,020,000

$675,500

References:
Stephen Schaltegeer, and Roger Burritt, Contemporary Environmental Accounting, Greenleaf Publishing Limited, Sheffield, U.D., 2000.
Jerry Kreuze, and Gale Newell, ABC and Life-Cycle Costing for Environmental Expenditures/ Management Accounting, February
1994, pp 38-42.
Robin Cooper, and Robert S. Kaplan,Measures Cost Right: Make The Right Decisions,
Harvard Business Review, September 1998, pp 96-104
Eliyahu M. Goldratt, and Jeff Cox, The Goal: A Process Of Ongoing Improvement, North River Press, Croton - On - Hudson, N.Y.
1986.
Robin Cooper and Roberts. Kaplan, The Design of Cost management Systems, Second Edition. Prentice-Hall, N.J. 1999.
Eric Noreen, Debra Smith, and James T. Mackey, The Theory Of Constraints and Its Implications For Management Accounting, North
River Press, Great Barrington, Mass., 1995
Environmental Considerations in Product Mix Decisions Using ABC and TOC, Julie Lockhart, and Audrey Taylor, Management
Accounting, fall 2007.

the management accountant, August, 2009

635

Issues in Taxation

Transfer Pricing - A Study


Debasish Dutt

ncome Tax Act 1961 does not


define Transfer Pricing. Simply put
transfer pricing is the term used to
describe the prices that related parties
set for transactions among themselves.
In other words transfer pricing would
mean the price at which commodities,
properties, services and intangibles are
traded across international borders
between related parties and cover the
tax levied on such inter corporate
transactions. According to Accounting
Standard-18, parties are considered to
be related if any time during the reported
period one party has ability to control
the other party or exercise significant
influence over the other party in
banking, financial and/or operating
decisions.
To ensure that transfer prices are not
manipulated and nations do not lose
their fair share of revenue in such cross
border transactions among related
parties, it is necessary to define the rules
of such international trading. The
fundamental principle is that transfer
pricing should be at arms length price.
The "arms length principle" of
transfer pricing states that the amount
charged by one related party to another
for a given product must be the same as
if the parties were not related. An "arms
length price" for a transaction is,
therefore, what the price of that
transaction would be on the open
market. For commodities, determining
the arm's length price by comparing
comparable pricing from non related
party transactions is relatively simple
(though not without problems).
However, determining the arm's length
price of services and intangibles is a
much more complicated matter. Both
M.com, AICWA, CAIIB, PGCGM (IIM),
MBA (USA), Senior General Manager
Simplex Infrastructures Limited

636

these issues are dealt with later.


Motivations for Transfer Pricing
Manipulation
The aim of transfer pricing
manipulation is to reduce a multi
national enterprise group's worldwide
taxation by shifting profits to low tax
countries through either under charging
or over charging an associated entity
for intra group trade. The net result of
transfer pricing manipulation is to
maximize a multi national enterprise's
after tax profits.
However, profits are not the only
motivation for transfer pricing
manipulation. Other factors could be
using pricing strategies to avoid or
mitigate local content requirement,
qualify for special treatment or avoid
legal barriers. Often a profit or loss in
one centre is transferred to another
division where tariff and subsidy
conditions exist. Alternatively, it can
transfer prices to diversify risk across
countries and currencies and thereby
obtain lower rates.
S. Plasschaert in "International
Transfer Pricing" summarizes the
different reasons why multi national
enterprises go in for manipulations in
Transfer Pricing. This is reproduced in
Table 1.
Transfer Pricing Regulations
The erstwhile Section 92 of Income
Tax Act 1961 with regard to transfer
pricing proved inadequate as it did not
cover the case of intangibles and
services in transactions between a
resident and a non resident. Moreover,
the emphasis was on profit rather than
on adjustments in prices and/or income/
expenses. As it did not define the close
parties, it gave opportunities for
unrestricted adjustments thereby
encouraging tax evasion. Further, as
there were no rules regarding

documentation, the entire burden of


proof fell on the assessing officer.
With a view to provide a detailed
statutory framework for the
computation of fair and equitable profits
of multinational enterprises, the
Finance Act 2001, based on the
recommendations of the Expert Group
under the Chairmanship of Mr. Raj
Narain, substituted Section 92 with a
new section and introduced new
sections 92A to 92F in the Income Tax
Act relating to computation of income
from an international transaction having
regard to the arm's length price, meaning
of associated enterprise, documents by
persons entering into international
transactions and definitions of certain
expressions.
The regulatory framework of
transfer pricing under Income Tax Act
and Rules framed thereunder is
summarized in Table 2.
The aforesaid provisions are
discussed under four broad headings
viz Definitions, Computation of Arm's
Length Price, Reference to Transfer
Pricing Officer and Documentation.
Definitions
According to Section 92A two
enterprises shall be deemed to be
associated enterprises if
1. one enterprise holds shares directly
or indirectly carrying not less than
26% voting power
2. any person or enterprise holds
shares directly or indirectly carrying
not less than 26% voting power
3. loan advanced by one enterprise
constitutes not less than 51% of the
book value of total assets of the
other enterprise
4. one enterprise guarantees not less
than 10% of the total borrowings of
the other enterprise
5. more than half of the board of
directors or one or more executive
directors of an enterprise are
appointed by the other enterprise

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Issues in Taxation

Table 1
Various inducements for Transfer Pricing
Hypothesis : the parent company sells to the subsidiary
Motivation

Action taken in multinational firm

Comments

Corporate Profit Tax

Underpricing

In case host country tax lower and


profits are not distributed as
dividends. Affects revenues in
two countries.

Customs Duties
Import Duties
Export Duties
Exchange Risks
Claim in weak currency

Underpricing
Underpricing

Affects revenue in only one country


Affects revenue in only one country

Overpricing plus leading

Claim in strong currency


Debt in weak currency
Debt in strong currency

Overpricing plus lagging


Overpricing plus lagging
Overpricing plus leading

Leading or lagging allows MNE to


avoid exchange risks; transfer
pricing enhances the benefits of
leading or lagging
-------------------------Do--------------------------------------------Do--------------------------------------------Do--------------------

Repatriation of profits or capital

Overpricing

Capitalizing machinery etc.

Overpricing

Also increases the basis of


depreciation allowances and of
compensation in case of
expropriation.

Joint Ventures

Overpricing

The "gain" from transfer pricing is,


by definition, shared with the joint
venture

Give support to claims for price


increases by showing higher costs

Overpricing

Avoiding anti-monopoly charges


Avoiding anti-dumping charges

Underpricing
Overpricing

Mollify claims for wage increases


by showing lower profits

Overpricing

Support an infant subsidiary

Underpricing

Enlarge market share to detriment


of competitors ("predatory pricing")

Underpricing

Provided lower cost is shifted into


lower price to consumer

Source : S.Plasschaert, "International Transfer Pricing", in International Financial Management Handbook, Kluwer, 1983
6. more than half of the directors or
one or more executive directors of
an enterprise are appointed by the
other enterprise
7. the manufacture, processing,
design, secret formula etc of one
enterprise is wholly dependent on
the use of patents, trademarks,
copyrights etc of the other enterprise

8. 90% of the raw materials and


consumables of an enterprise
required for manufacture or
processing is supplied by the other
enterprise or persons specified by
the other enterprise and prices etc
are influenced by the other
enterprise
9. the goods manufactured or
processed by one enterprise is sold

the management accountant, August, 2009

to the other enterprise or persons


specified by the other enterprise
and prices etc are influenced by the
other enterprise
10. where one enterprise is controlled
by an individual, the other enterprise
is also controlled by that individual
or his relative or jointly with his
relative
637

Issues in Taxation

TABLE 2
Provisions
Act and

regarding Transfer Pricing in Income Tax


Rules framed thereunder

Act

Provisions

Section 92
Section 92 A

Computation of income from international transactions


involving transfer pricing having regard to arms length price
Meaning of Associated Enterprise

Section 92 B

Meaning of International Transaction

Section 92 C

Computation of arms length price

Section 92 CA Reference to transfer pricing officer


Section 92 D

Maintenance of documents and information

Section 92 E
Section 92 F

Requirement of audit report


Important definitions

Rules

Provisions

10 A

Meaning of expression used in arms length price

10 B

Determination of arms length price under Section 92 C

10 C

Most appropriate method

10 D

Information and documents to be kept and maintained


under Section 92 D
Report from an accountant to be furnished under
Section 92 E

10 E

11. where one enterprise is controlled


by a HUF, the other enterprise is also
controlled by a member of that HUF
or his relative or jointly with his
relative

transaction having a bearing on the


profits, income losses or assets of such
enterprises; or mutual cost sharing
agreement.

12. where one enterprise is a firm,


association of persons (AOP) or
body of individuals, the other
enterprise holds not less than 10%
interest in such firm, AOP or body
of individuals
13. there exists between the two
enterprises any relationship of
mutual interest as may be
prescribed.

Section 92F(ii) defines arms length price


as a price which is applied or proposed
to be applied in a transaction between
persons other than associated
enterprises, in uncontrolled conditions.

Section 92B defines an international


transaction to mean a transaction
between two or more associated
enterprises where either or both of them
are non residents. It includes
transactions in the nature of purchase,
sale or lease of tangible or intangible
property; provision of services; lending
or borrowing money; any other
638

Section 92F(iii) defines enterprise to be


a person (including a permanent
establishment of such person) who is,
or has been, or is proposed to be,
engaged in any activity, relating to the
production,
storage,
supply,
distribution, acquisition or control of
articles or goods, or know-how, patents,
copyright, trademarks, licences,
franchises, or any other business or
commercial rights of similar nature, or
any data, documentation, drawing or
specification relating to any patent,

invention, model, design, secret formula


or process, of which the other enterprise
is the owner or in respect of which the
other enterprise has exclusive rights, or
the provision of service of any kind, (or
in carrying out any work in pursuance
of a contract,) or in investment, or
providing loan or in the business of
acquiring holding underwriting or
dealing with shares, debentures or other
securities of any other body corporate,
whether such activity or business is
carried on, directly or through one or
more of its units or divisions or
subsidiaries, or whether such unit or
division or subsidiary is located at the
same place where the enterprise is
located or at a different place or places.
Section 92F(iiia) defines permanent
establishment to include a fixed place
of business through which the business
of the enterprise is wholly or partly
carried on
Section 92F (v) defines a transaction
to include an arrangement, understanding or action in concert, a) whether
or not such arrangement, understanding
or action is formal or in writing or b)
whether or not such arrangement,
understanding or action is intended to
be enforceable by legal proceeding.
Rule 10A defines transaction to include
a number of closely linked transactions.
Uncontrolled transaction means a
transaction between enterprises other
than associated enterprises, whether
resident or non resident (Rule 10A)
Property includes goods, articles or
things, and intangible property (Rule
10A)
Services include financial services
(Rule 10A)
Computation of Arm's Length Price
Sub section (1) of Section 92 of the
Income Tax Act 1961 stipulates that the
income arising from an international
transaction shall be computed having
regard to the arm's length price. Section
92C(1) prescribes the following methods
for computation of arm's length price:
a) Comparable Uncontrolled Price
(CUP) Method;

the management accountant, August, 2009

Issues in Taxation

b)
c)
d)
e)

Resale Price Method (RPM)


Cost Plus Method (CPM)
Profit Split Method (PSM)
Transactional Net Margin Method
(TNMM) and
f) Such other method as may be
prescribed by CBDT.
Rule 10B (1) stipulates that for the
purposes of sub-section (2) of section
92C, the arm's length price in relation to
an international transaction shall be
determined by any of the aforesaid
methods being the most appropriate
method. The rules for computation of
arm's length price (Rule 10B) are
discussed below.
Comparable Uncontrolled Price (CUP)
Method
Under comparable uncontrolled
price method the price charged for
goods or services transferred in a
controlled transaction is compared to
the price charged in a comparable
uncontrolled transaction. It is the price
for near identical property traded
between two independent parties in
similar circumstances. It assumes that
a comparable price exists for sale or
purchase of similar goods from
independent parties.
This method gives rise to two kinds
of comparables viz the internal CUP and
the external CUP. The internal CUP
compares the price charged by an
enterprise in a transaction with an
associated enterprise with the price
charged by the same enterprise in an
independent transaction with a third
party. The external CUP compares the
price charged by an enterprise in a
controlled transaction with the price
charged between two unrelated parties
in a similar transaction.
Example
A Co. sells electronic gadgets to B
Co. a related party. It also sells
electronic gadgets to C Co. an unrelated
person for USD 100. Under CUP method
A Co. would charge B Co. USD 100 (with

possible adjustments for differences in


shipping costs etc.)
Resale Price Method (RPM)
The resale price starts with the price
at which a product or service is sold to
an independent third party by a related
enterprise which is the seller. This price
is reduced by the gross profit margin
taking into account the relevant costs
and expenses of the seller and also
reasonable profit in the light of functions
performed and the risks involved.
Example
A Co. sells electronic gadgets to B
Co. a related party and B Co. sells them
to unrelated retail customers for USD
200 each. Distributors in similar line of
business usually earn 20% of the sales
price. Under Resale Price Method the
price on the sale from A Co. to B Co.
would be USD 160 (USD200 - (20% of
USD 200)).
Cost Plus Method (CPM)
Under this method the first step is
to determine the direct and indirect cost
of production incurred by the enterprise
in respect of property transferred or
services provided to an associated
enterprise. The next step is to determine
the normal gross profit markup to such
costs in unrelated enterprises. Next the
normal gross profit markup is to be
adjusted on account of functional and
other differences between the
transactions which are being compared.
Such profit markup is then added to the
cost calculated as per the first step.
Example
A Co. manufactures electronic
gadgets at USD 50, sells them to B Co. a
related person and B Co. sells them to
unrelated retail customers for USD 200.
Manufacturers in similar line of
business typically earn a gross profit
of 30%. Under Cost Plus Method the
price on the sale from A Co. to B Co. is
USD 65 (USD 50 + (30% of USD50).
Profit Split Method (PSM)
Under this method the first step is

the management accountant, August, 2009

to determine the combined net profit of


the "Associated enterprise" arising
from the international transaction in
which the enterprises are engaged. The
relative contribution made by each of
the associated enterprises to the
combined net profit is then evaluated
on the basis of functions performed,
assets employed and risks assumed by
each enterprise and on the basis of
reliable external market data which
indicates how such contribution would
be evaluated. The combined profit is
then split amongst the enterprises in
proportion to their relative contributions
and such apportioned profit to the
assessee is taken into account to arrive
at the arm's length price in relation to
the international transaction.
Under this method, if required,
firstly, the combined net profit may be
partially allocated to each enterprise on
the basis of basic market return for
similar types of transactions by
independent enterprises and thereafter
the residual net profit may be split
amongst the enterprises in proportion
to their relative contribution and the total
of both shall be taken to be the profit
arising to the enterprise from the
international transaction.
Example
A Co. and B Co. are related persons
engaged in the production and sale of
electronic gadgets. A Co. engages in
lots of R&D to produce the gadgets. B
Co. sells the gadgets after affixing its
trade name to the packaging. They earn
profits of USD 8 million from the
business. Based on comparisons with
unrelated persons, the tax department
of the country determines that A Co.
contributions to the business accounts
for about 75% of the profits. Its taxable
profits would be USD 6 million (75% of
USD 8 million).
Transactional Net Margin Method
(TNMM)
Under this method, first the net profit
margin realized by the enterprise from
an international transaction entered into
639

Issues in Taxation

with an associated enterprise is


computed in relation to costs incurred
or sales effected or assets employed/to
be employed by the enterprise or any
other relevant base. Then the net profit
realized by the enterprise or by an
unrelated enterprise from one or more
comparable uncontrolled transaction is
computed and then adjusted to take
account the differences between the
international transaction and the
comparable uncontrolled transactions
which could materially affect the
amount of net profit margin in the open
market. Then the net profit margin
realized by the enterprise is established
with the net profit margin computed out
of comparable uncontrolled transaction
and the net profit margin thus
established shall be taken into account
to arrive at the arm's length price.
Example
A Co. is an independent distributor
of electronic gadgets which it purchases
from unrelated manufacturers. The ratio
of its profits to its gross revenues is
1:10. B Co. manufactures electronic
gadgets which it sells to C Co. a related
person. C Co. has gross receipts from
the sale of the electronic gadgets of
USD 30 million. Under Transactional
Net Margin Method its profits would
be USD 3 million (USD 30 million x 1/
10). If the overall profits of B Co. and C
Co. are USD 8 million, then B Co. would
have profits of USD 5 million (USD 8
million - USD 3 million).
Such other method as may be prescribed
by CBDT.
CBDT has, however, not prescribed
any other method other than the
methods stipulated in 92C(1).
Most Appropriate Method
The most appropriate method
according to Rule 10C is that method
which provides the most reliable
measure of arm's length price and in
selecting such a method factors like
nature of the international transaction,
the function and assets employed by
640

the associated enterprises, availability


and reliability of the data necessary for
application of the method, the degree
of comparability existing between the
international transaction and the
uncontrolled transaction, the extent to
which reliable adjustments can be made
to account for differences and the
reliability of the assumptions required
to be made should be taken into account
2.3. Reference to Transfer Pricing
Officer
Section 92CA stipulates that the
Assessing Officer may, if he considers
it necessary, with the previous approval
of the Commissioner, refer the
computation of the arms length price in
relation to an international transaction
of an assessee to the Transfer Pricing
Officer who would then serve a notice
to the assessee requiring him to
produce on a specific date evidence in
support of the computation made by
him. (It may be mentioned in this
connection that the Finance Ministry
has issued guidelines to select
compulsorily all cases where the value
of international transaction between
associated enterprises is in excess of
Rs.5 crores which has been increased
to Rs. 15 crores from 2005-06). On that
date the Transfer Pricing Officer shall,
after hearing the evidence and
considering the documents under
Section 92D(3), by order in writing,
determine the arm's length price and
send a copy of his order to the
Assessing Officer and to the assessee.
On receipt of the order the Assessing
Officer will proceed to compute the total
income of the assessee under Section
92C.
It needs to be pointed out that The
Finance Bill 2007 modified Section
92CA(4) laying down that the opinion
given by the TPO will be binding on the
AO as the TPO is an expert in matters
concerning the arm's length price. Prior
to The Finance Bill 2007 Section 92CA(4)
read as under :
"On receipt of the order under sub

section (3) the Assessing Officer shall


proceed to compute the total income of
the assessee under sub section (4) of
section 92C having regard to the arm's
length price determined under sub
section (3) by the Transfer Pricing
Officer."
The AO therefore can no longer
apply his discretion and will have to
compute the total income of the
assessee in conformity with the arm's
length price determined by the TPO. To
this extent the Delhi High Court ruling
in Sony India (P) Limited v CBDT 288
ITR 52 where the Delhi High Court had
held that the AO is not bound to accept
the arm's length price as determined by
the TPO, stands modified.
The Finance Bill 2007 had also
revised the time limit for making
assessment/reassessment in cases
where a reference is made to TPO. The
TPO is now required to complete the
assessment within 31 months from the
end of the relevant assessment year for
determining the arm's length price.
Sections 153 (time limit for assessment
and reassessment) and 153B (time limit
for completion of assessment under
Section 153A) have been modified for
this purpose. Assessments pending as
on June 1, 2007 will be governed by the
new amendment to Section 92C(4). Such
assessments will have to be completed
within 21 months from the end of the
assessment year in which the income
tax was assessable.
Search
assessments will now require the
approval of the Joint Commissioner.
Orders for special audit require
submission of show cause notice.
Radical changes have also been effected
with regard to the functioning of the
Settlement Commission.
2.4. Documentation
Section 92D provides that every
person entering into an international
transaction shall keep and maintain such
information and documentation as may
be prescribed.
The prescribed documents are

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Issues in Taxation

detailed in Rule 10D(1) which are


summarized below :
1. ownership structure of the assessee
2. profile of the multinational group of
which assessee is a part
3. broad description of the business
of the assessee and the industry in
which he operates
4. nature and terms (including prices)
of international transactions
entered into with each associated
enterprise
5. description of functions, risks and
assets employed by assessee and
by the associated enterprise
6. record of market analysis, forecasts,
budgets, financial analysis prepared
by assessee
7. record of uncontrolled transactions
for analyzing their comparability
with the international transactions
entered into by the assessee
8. record of analysis performed for
analyzing comparability of
international transactions
9. description of methods considered
for arms length price in relation to
each international transaction and
the method selected
10. record of actual workings for
determining arms length price and
information used in determining the
most appropriate method with
adjustments if any
11. assumptions, policies and price
negotiations which have critically
affected the determination of arms
length price

12. details of adjustments made to accountant has to certify that in his


transfer prices to align them to arms opinion proper information and
documents as appears from examination
length prices
13. any other information data or of the records maintained by the
document which may be relevant for assessee have been kept.
Penalties for non compliance
determining arms length price
The penalty provisions for non
Rule 10D(2) exempts the
maintenance of detailed records compliance of the transfer pricing
prescribed under Rule 10D(1) if the regulations are summarized in Table 3
international transactions entered into
Section 273B, however, provides
by the assessee does not exceed Rs.1.00 that the penalties referred to in the above
crore.
table will not be imposed if the assessee
Section 92E requires every person can prove that there was reasonable
who has entered into an international cause for such failures.
transaction during an accounting period
The term reasonable cause should
to furnish a report of a Chartered be interpreted to mean a "cause which
Accountant in Form 3CEB (Table 3). The prevents a reasonable man of ordinary
TABLE 3
FORM NO. 3CEB
(Rule 10E)
Report from an accountant to be furnished under section 92E relating
to international transaction(s)
1 I/We have examined the accounts and records of
(name and address of the assessee with PAN) relating to the
international transactions entered into by the assessee during the
previous year ending on 31st March, ___________
2 In my/our opinion proper information and documents as are
prescribed have been kept by the assessee in respect of the
international transaction(s) entered into so far as appears from my/
our examination of the records of the assessee.
3 The particulars required to be furnished under section 92E are given
in the Annexure to this Form. In my/our opinion and to the best of
my/our information and according to the explanations given to me/
us, the particulars given in the Annexure are true and correct
Signed
Name
Place
Address
Date
Membership No.

Table 3
Penalties Under Transfer Pricing Regulations
Section
Non compliance with procedural requirements
Section 271(1)( c ) read
with explanation 7 to
section 271 (1)
Section 271AA

Concealment of income (unless computation of


arm's length principle is in accordance with
Section 92( c )
Failure to maintain documents

Section 271BA
Section 271G

Failure to furnish accountant's report


Failure to furnish documents

the management accountant, August, 2009

Nature of penalty
100% to 300% of tax on the
adjusted income
2% of the value of each
international transaction
Rs.1,00,000
2% of the value of the
international transaction
641

Issues in Taxation

prudence acting under normal


circumstances, without negligence or
inaction or want of bona fides, from
undertaking that action" (CWT v Sri
Jagdish Prasad Choudhury (1995) 211
ITR 472 (Pat) Also Azadi Bachao
Andolan v Union of India (2001) 252
ITR 471 (Delhi). While examining
reasonableness a long term view need
to be taken. Keeping in view the
important role of technical assistance
in the business, royalty payments
amounting to approximately 50% of
profits that the company would have
earned had such payments not been
made were held to be reasonable cause
Where "cause shown by the assessee
explains a part of the delay or cause only
mitigates the gravity of non
compliance", it cannot be considered
as a good cause for non compliance
In CIT v Late H.H.Maharaja
Bhagwat Singh (197) 226 ITR 91 (Raj) it
was held that a penalty should not be
imposed merely because it is lawful to
do so. It should be based on "all facts
and specific finding of facts".
Transfer Pricing Provisions in other
statutes
Transfer pricing regulations and
penalties also covered in other statutes
some of which are discussed below:
Transfer Pricing provisions in
Companies Act
Section 212 requires the holding
company to attach with its Balance
Sheet certain information pertaining to
its subsidiary/subsidiaries.
Section 594 provides that every
company shall, in every calendar year,
make out a Balance Sheet and Profit and
Loss account in such form containing
such particulars and including or having
annexed or attached thereto such
documents (including in particular
documents relating to every subsidiary
of the foreign company) as a domestic
company. and 615 of the Companies Act
require disclosure of information about
operations which includes finances of
subsidiaries.
642

Transfer Pricing provisons in


Customs Act
Sections 14 of the Customs Act and
the Customs Valuation Rules 1988
require valuation of all transactions
which are not arms length. Sections 112
and 114 provides for penalty for
"improper" transactions and Section
111 and 113 allows for confiscation.
Appeals against decisions are covered
in Section 128, constitution of an
Appellate Tribunal (Section 129),
referring to High Court (Section 130) and
to Supreme Court (Section 130-E)
Differences/Anamolies in transfer
pricing provisions/inferences of the
Income Tax Act 1961 with other statutes
It needs to be mentioned, however,
that there are certain anamolies with
other statutes with respect with transfer
pricing provisions which are discussed
below:
Transfer Pricing and FEMA
Secton 8 of FEMA states :
"Save as otherwise provided in this
Act, where any amount of foreign
exchange is due or has accrued to any
person resident in India such person
shall take all reasonable steps to realise
and repatriate to India such foreign
exchange within such period and in
such manner as may be specified by the
Reserve Bank".
The question is can an Indian
resident bring into India more foreign
exchange due to an adjustment made
by Income Tax Authorities. For example
if a subsidiary remits royalty of say
Rs.10.00 lacs and the Income Tax
authorities determine that the arms
length royalty should be Rs.20.00 lacs,
can the Indian company bring in the
additional royalty of Rs.10.00 lacs to
India.
2. Currently consultancy fees upto
USD 100,000 can be remitted abroad
under the automatic route and any
remittance over USD100,000 requires the
specific approval of RBI who may accept
or reject the application. The question

is whether RBI approval tantamounts


to being at arms length price. If an
application for consultancy fees higher
than USD 100,000 is rejected by RBI,
can Income tax authorities assess the
foreign parent company for arms length
price.
Transfer Pricing and Customs
1. Under the Customs Valuation
Rules the invoice value of imported
goods or the "transaction value" can
be accepted as the "assessable value"
only if the customs authorities are
satisfied of the accuracy of the value
declared. Rule 4(2) stipulates eight
more conditions relating to the sale
being under competitive conditions, the
prices charged having no abnormal or
special discounts, etc. for the
transaction value to be accepted as the
"assessable value".
The question that arises is whether
the income tax department will accept
the "accessible value" as the arms
length price. Further, if the income tax
department arrives at an arms length
price different from "accessible value",
then will the customs department
reopen the assessment and revalue the
imports. According to Section 127E of
the Customs Act the customs
authorities can reopen assessments
within a period of five years if they
consider it necessary.
2. There is an inherent conflict of
interest between customs authorities
and income tax authorities regarding
transfer pricing. While the customs
authorities will prefer a higher transfer
price on imports to increase customs
duty, the income tax authorities will
prefer a lower transfer price on the same
imports to stop diversion of profits to
the exporting country.
Transfer Pricing and Accounting
Standards
According to AS18 a person/
enterprise who holds 20% or more
interest in the voting power of another
enterprise will be considered as a

the management accountant, August, 2009

Issues in Taxation

"related party" whereas according to


Income Tax Act a person/enterprise
would be deemed to be a "related party'
if he holds shares carrying not less than
26% of the voting power in another
enterprise.
Transfer Pricing and FIPB and RBI
For transferring shares of an Indian
company from a resident to a non
resident company approval of FIPB and
RBI is required. FIBP ensures that the
purchase is in conformity with the
foreign investment policy. It does not
comment on price. RBI ensures that the
selling price of shares is above the
basic floor price. It does not scrutinize
the selling price.
The question that arises is whether
the income tax department can adjust
the selling prices of shares which are
approved both by FIPB and RBI.
Transfer Pricing and Double Taxation
Avoidance Agreements
Section 115-O of the Income Tax
Act, 1961 levies distribution tax on
dividend distributed by Indian
Companies at the rate of 15% plus
surcharge whereby the subsidiaries of
US companies who declare dividends
in India also have to pay this tax.
However the existing DTAA with USA
does not take into account the Dividend
Distribution Tax.
Arms Length Principle for Intangibles
A separate paragraph on arm's
length principle for intangibles is
included as it is difficult to apply the
arm's length principle to intangibles
(royalty, technical service fee, fee for
use of licence, trademarks etc) because
of ambiguity in defining "intangibles"
and also due to the difficulty of
assigning a specific value for the
purpose of taxation. Valuation of
intangibles is very much subjective and
depends on various factors affecting a
particular transaction. The five
prescribed methods are often found to
be inadequate to deal with transfer
pricing issues relating to intangibles.

In Foster's Australia Ltd. v


Commissioner of Income Tax the
Authority for Advance Ruling held that
under Indian tax laws, income arising
from the transfer of capital assets
situated in India is taxable in India.
Based on existing case laws, it was held
that trade marks, brand names, technical
know-how would be treated as capital
assets. The Authority held that the
place in which intangibles are registered
does not have a bearing in determining
the location of such intangibles, which
is taken to be wherever such assets are
utilized. Further, as intangible assets
could have multiple locations, the tax
residency of the owner of the intangible
cannot determine their location.
Transfer Pricing Audit - Key issues
that affect tax payers
Some of the key issues which affect
taxpayers during transfer price audit
include usage of multiple year data,
benefit of safe harbour provisions,
selection of foreign comparable
companies, financial adjustment to the
comparable data, availability of
contemporaneous data, usage of secret
comparables and preference of
transaction-specific approach by
revenue authorities over an aggregated
approach adopted by the taxpayers.
The taxpayers have to justify that the
transfer price charged by them is based
on the commercial nature of a low profit
margin and is not erroneous.
It may be appropriate at this stage
to discuss in brief some of the issues in
the important case laws on transfer
pricing. As can be seen most of the
cases sited below deal with the issues
referred to above.
Sony Private India Ltd. v Delhi Income
Tax Appellate (Sept 23, 2008)
In this ruling the Income Tax
Appelate Tribunal (ITAT) stated that
India's transfer price regulations take
account of safe harbour, even though
the regulations do not expressly refer
to one. The Tribunal held that any
taxpayer may choose the option of

the management accountant, August, 2009

determining the appropriate transfer


price by making adjustments within a 5
percent range of the uncontrolled price.
The Tribunal relied on the Kolkata
ITAT's ruling in Development
Consultants Pvt. Ltd. V DCIT which
was the first to uphold the 5 percent
safe harbour.
Philips Software Centre Private
Limited V ACIT (Sept 26, 2008)
The Bangalore ITAT held that any
monetary exchange from a related party
transaction, no matter how small,
requires that a comparable be rejected.
The Tribunal set aside the transfer
pricing assessment for 2003-2004
because the transfer pricing officer
inappropriately disregarded the
taxpayer's transfer pricing study and
replaced it with his own because the
officer did not examining the taxpayer's
use of the cost plus method and the
choice of database used to acquire
comparables.
E-Gain Private Ltd. v Income Tax
Officer (6/10/08)
The Pune ITAT held that the size
and scope of operations, stage and
business, or product cycle should be
considered
in
determining
comparability. This is in contrast to
Mentor Graphics Pvt Ltd. V DCIT, in
which the Delhi ITAT said turnover is
not a relevant criterion for comparables
selection.
Set Satellite (Singapore) Private
Limited v DDIT
The Mumbai High Court held that
an agency permanent establishment
that was paid arm's length prices by its
foreign principal would have no further
profits attributed to it in India. In
contrast, in Rolls Royce Plc V
Dep.Director of Income Tax the Delhi
ITAT attributed an extra 35 percent of
sales profit to the agency PE for its
marketing activities.
Hindustan Unilever Limited v
D.A.Sheldekar, Transfer Pricing Officer
-1 (Oct 22, 2008)
643

Issues in Taxation

The Bombay High Court held that if


the law permits the assessee to change
his stand, neither the Revenue nor the
Court would be justified to deny such
an opportunity.
DIT v Morgan Stanley & Co. (2007)
292 ITR 416 (SC)
The Supreme Court viewed that in
case of service permanent establishment
the transaction net margin method is the
most appropriate method.
Pfizer Corporation v Commissioner of
Income Tax (2003) 180 CTR 319 (Bom)
The Bombay High Court held that a
non resident can follow cash basis
system for his accounting.
Mentor Graphics (Noida) Private
Limited v Dy. CIT ITA, NO.1969/D/
2006
Appropriate adjustments relating to
functional, asset and risk differences are
necessary while choosing comparable
enterprises in Transfer Pricing analysis.
UCB India Pvt. Ltd. V ACIT ITA Nos.
428 & 429/MUM/2007
When the burden of proving that a
particular method is the most
appropriate method is initially on the
assessee, it is for the assessee to
demonstrate the same by furnishing
adequate records and data, irrespective
of the fact whether they are statutorily
required or not; once the method
adopted by the assessee is rejected, the
revenue is duly bound to compute the
arm's length price by adopting a most
appropriate method and it has also to
substantiate and justify the use of such
method.
Ranbaxy Laboratories v Addl CIT
(2008) (299 ITR 175)
"Selecting overseas AEs as tested
party for purpose of comparison to
apply transfer pricing regulations is
wrong. If a taxpayer wishes to take
foreign AEs as tested party and
compared the margin with the foreign
comparables, then it must ensure that it
is such an entity for which relevant data
644

for comparison is available in public


domain and is furnished to tax
administration."
Conclusion
The procedure and the method of
implementing transfer pricing norms in
India are still at a nascent stage and it is
expected that with the passage of time
these will attain maturity. Applying
transfer pricing rules based on arm's
length principle is not easy and it is not
always possible to find comparable
market transactions to set an acceptable
transfer price. The following aspects
need to be considered to make the
provisions more investor friendly.
Comparable Market Transactions
A major challenge in implementation
of transfer pricing regulations is non
availability of reliable databases which
offer suitable comparables with regard
to cross border transactions. In India
there are only two commercial data
bases (Prowess and Capitalline Plus)
which contain financial information of
about 10,000 public and private
companies. However, these databases
are not primarily designed for Transfer
Pricing analysis. For effective
administration of transfer pricing
policies, more comprehensive
databases are required. There are
several databases available with
Customs Department like NIDB
(National Import Database), Export
Commodity Database (ECDB), Special
Valuation Database (SVB), Valuation
Instructions, Valuation Alerts and the
Valuation Bulletin. Sharing information
contained in these databases would be
beneficial to both the departments in
taking decisions on Transfer Pricing
issues.
Appropriateness of arithmetic mean as
statistical measure to determine arm's
length price
Indian transfer pricing regulations
require that the price for related party
transactions be determined having
regard to the arm's length price. The

arms length price has been defined to


mean the arithmetic mean of the range
of prices for comparables. However, the
arithmetic mean as a statistical measure,
tends to get skewed by extreme values
in the comparable set. Ideally the interquartile range which eliminates the
extreme values in a range of
observations should be used to measure
comparability.
Use of contemporaneous data
Rule 10D(4) provides that the
information and documents to be
maintained by the assessee should as
far as possible be contemporaneous.
Contemporaneous data means data with
respect to the financial year in which
the international transaction has taken
place. Only sometimes, data pertaining
to two years prior to the transaction is
allowed. Since transfer pricing is not a
single year transaction issue and all
multiple year transactions have to be
taken into account, companies' business
cycles need to be acknowledged.
Ideally averaging of business cycles
should be allowed by adopting a
multiple year analysis. This is in line
with the recommendations on the OECD
transfer pricing guidelines.
Safe Harbour provisions
Income Tax Act lays down detailed
stipulations in respect of determination
of arm's length price in the context of
international transactions with
associated enterprises, within the safe
harbour limits of (+)(-) 5% of the
arithmetic mean of the price computed
as per methods prescribed. In other
words the Assessing Officer would
accept the transfer price as determined
by the taxpayer if the price is upto 5%
more or less than the price determined
by the Assessing Officer. The safe
harbour concept is designed to relieve
small taxpayers from administrative
burdens and compliance cost. The safe
harbour limits should ideally be
increased to (+)(-) 25% of the arithmetic
mean of the price. Also, to avoid
uncertainties in the positions and
Contd. on Page 651

the management accountant, August, 2009

Accounting Issues

IAS 20, Accounting for


Government Grants and
Disclosure of Government
Assistance - A Closer Look
K.S.Muthupandian*

nternational Accounting Standard


(IAS) 20, Accounting for
Government Grants and Disclosure
of Government Assistance, prescribes
the accounting for government grants.
In September 1981, the International
Accounting Standards Committee
(IASC) issued the Exposure Draft E21,
Accounting for Government Grants and
Disclosure of Government Assistance.
In April 1983, the IASC issued IAS 20,
Accounting for Government Grants and
Disclosure of Government Assistance,
effective from January 1, 1984. In 1994,
the IAS 20 (1983) was reformatted. On
May 22, 2008, IAS 20 amended for
'Annual Improvements to International
Financial Reporting Standards (IFRSs)
2008', effective from January 1, 2009.
Objective
The objective of IAS 20 is to
prescribe the accounting treatment for,
and disclosure of, government grants
and other forms of government
assistance.
Government assistance takes many
forms varying both in the nature of the
assistance given and in the conditions
which are usually attached to it. The
purpose of the assistance may be to
encourage an entity to embark on a
course of action which it would not
*M.Com., FICWA and Member of Tamil
Nadu State Treasuries and Accounts Service,
presently working as Treasury Officer,
Ramanathapuram District, Tamil Nadu.
Email: ksmuthupandian @ ymail. com /
ksmuthupandian@gmail.com

normally have taken if the assistance


was not provided.
The receipt of government
assistance by an entity may be
significant for the preparation of the
financial statements for two reasons.
Firstly, if resources have been
transferred, an appropriate method of
accounting for the transfer must be
found. Secondly, it is desirable to give
an indication of the extent to which the
entity has benefited from such
assistance during the reporting period.
This facilitates comparison of an entity's
financial statements with those of prior
periods and with those of other entities.
Scope and Application
IAS 20 applies to all government
grants and other forms of government
assistance, but does not apply to:
l Government assistance that is
provided for an entity in the form of
benefits that are available in
determining taxable income or are
determined or limited on the basis
of income tax liability (such as
income tax holidays, investment tax
credits, accelerated depreciation
allowances and reduced income tax
rates)
l Government participation in the
ownership of the entity, i.e. grantsin-aid or (less likely) grants given to
support the general revenue and
capital expenditure of an entity
l Government grants covered by IAS
41, Agriculture.
l Special problems arising in

the management accountant, August, 2009

accounting for government grants


in financial statements reflecting the
effects of changing prices or in
supplementary information of a
similar nature.
The benefit of a government loan at
a below-market rate of interest is treated
as a government grant. Government
grants are sometimes called by other
names such as subsidies, subventions,
or premiums.
Key Definitions
Fair value is the amount for which
an asset could be exchanged between a
knowledgeable, willing buyer and a
knowledgeable, willing seller in an arm's
length transaction.
Forgivable loans are loans which the
lender undertakes to waive repayment
of under certain prescribed conditions.
Government refers to government,
government agencies and similar bodies
whether local, national or international.
Government assistance is action by
government designed to provide an
economic benefit specific to an entity
or range of entities qualifying under
certain criteria. Government assistance
for the purpose of this Standard does
not include benefits provided only
indirectly through action affecting
general trading conditions, such as the
provision of infrastructure in
development areas or the imposition of
trading constraints on competitors.
Government grants are assistance
by government in the form of transfers
of resources to an entity in return for
past or future compliance with certain
conditions relating to the operating
activities of the entity. They exclude
those forms of government assistance
which cannot reasonably have a value
placed upon them and transactions with
government which cannot be
distinguished from the normal trading
transactions of the entity.
Grants related to assets are
government grants whose primary
condition is that an entity qualifying for
645

Accounting Issues

them should purchase, construct or


otherwise acquire long-term assets.
Subsidiary conditions may also be
attached restricting the type or location
of the assets or the periods during
which they are to be acquired or held.
Grants related to income are
government grants other than those
related to assets.
Prescribed Accounting Treatment
Why Bother Reporting Receipts of
Government Grants?
Firstly, if resources have been
transferred, an appropriate method of
accounting for the transfer must be
found.
Secondly, it is desirable to give an
indication of the extent to which the
entity has benefited from such
assistance during the reporting period.
Recognition of Government Grants
Government grants, including nonmonetary grants at fair value, shall not
be recognised until there is a reasonable
assurance that:
l the entity will comply with the

conditions attaching to the grants


l the grants will be received.

Government grants include grants


of cash and non-monetary assets, and
reductions of liabilities. They are
recognised at their fair value. After
recognition, any related contingent
liability or contingent asset is treated in
accordance with IAS 37, Provisions,
Contingent Liabilities and Contingent
Assets.
The manner in which a grant is
received does not affect the accounting
method to be adopted in regard to the
grant.
Accounting
Treatment
of
Government Grants
Two broad approaches may be
found to the accounting treatment of
government grants: the capital
approach, under which a grant is
credited directly to shareholders'
646

interests, and the income approach,


under which a grant is taken to income
over one or more periods.
Capital Approach: Those in support
of the capital approach argue as
follows:
(a) government grants are a financing
device and should be dealt with as
such in the balance sheet rather than
be passed through the income
statement to offset the items of
expense which they finance. Since
no repayment is expected, they
should be credited directly to
shareholders' interests; and
(b) it is inappropriate to recognise
government grants in the income
statement, since they are not earned
but represent an incentive provided
by government without related
costs.
Income Approach: Arguments in
support of the income approach are as
follows:
(a) since government grants are
receipts from a source other than
shareholders, they should not be
credited directly to shareholders'
interests but should be recognised
as income in appropriate periods;
(b) government grants are rarely
gratuitous. The entity earns them
through compliance with their
conditions and meeting the
envisaged obligations. They should
therefore be recognised as income
and matched with the associated
costs which the grant is intended to
compensate; and
(c) as income and other taxes are
charges against income, it is logical
to deal also with government grants,
which are an extension of fiscal
policies, in the income statement.
It is fundamental to the income
approach that government grants be
recognised as income on a systematic
and rational basis over the periods
necessary to match them with the
related costs. Income recognition of

government grants on a receipts basis


is not in accordance with the accrual
accounting assumption (see IAS 1,
Presentation of Financial Statements)
and would only be acceptable if no
basis existed for allocating a grant to
periods other than the one in which it
was received.
In most cases the periods over which
an entity recognises the costs or
expenses related to a government grant
are readily ascertainable and thus
grants in recognition of specific
expenses are recognised as income in
the same period as the relevant expense.
Similarly, grants related to depreciable
assets are usually recognised as income
over the periods and in the proportions
in which depreciation on those assets
is charged.
Grants related to non-depreciable
assets may also require the fulfilment
of certain obligations and would then
be recognised as income over the
periods which bear the cost of meeting
the obligations. As an example, a grant
of land may be conditional upon the
erection of a building on the site and it
may be appropriate to recognise it as
income over the life of the building.
Grants are sometimes received as
part of a package of financial or fiscal
aids to which a number of conditions
are attached. In such cases, care is
needed in identifying the conditions
giving rise to costs and expenses which
determine the periods over which the
grant will be earned. It may be
appropriate to allocate part of a grant
on one basis and part on another.
A government grant that becomes
receivable as compensation for
expenses or losses already incurred or
for the purpose of giving immediate
financial support to the entity with no
future related costs shall be recognised
as income of the period in which it
becomes receivable.
In some circumstances, a
government grant may be awarded for

the management accountant, August, 2009

Accounting Issues

the purpose of giving immediate


financial support to an entity rather than
as an incentive to undertake specific
expenditures. Such grants may be
confined to an individual entity and may
not be available to a whole class of
beneficiaries. These circumstances may
warrant recognising a grant as income
in the period in which the entity
qualifies to receive it, with disclosure
to ensure that its effect is clearly
understood.
A government grant may become
receivable by an entity as compensation
for expenses or losses incurred in a
previous period. Such a grant is
recognised as income of the period in
which it becomes receivable, with
disclosure to ensure that its effect is
clearly understood.
Presentation of grants
Grants related to assets
Government grants related to assets,
including non-monetary grants at fair
value, shall be presented in the balance
sheet either by setting up the grant as
deferred income, or by deducting the
grant in arriving at the carrying amount
of the asset.
Two methods of presentation in
financial statements of grants (or the
appropriate portions of grants) related
to assets are regarded as acceptable
alternatives. One method sets up the
grant as deferred income which is
recognised as income on a systematic
and rational basis over the useful life of
the asset. The other method deducts
the grant in arriving at the carrying
amount of the asset. The grant is
recognised as income over the life of a
depreciable asset by way of a reduced
depreciation charge.
The purchase of assets and the
receipt of related grants can cause major
movements in the cash flow of an entity.
For this reason and in order to show
the gross investment in assets, such
movements are often disclosed as
separate items in the cash-flow

statement regardless of whether or not


the grant is deducted from the related
asset for the purpose of balance sheet
presentation.
Grants related to income
Grants related to income are
presented as (a) a deferred credit in the
income statement, either separately or
under a general heading such as 'other
income' or (b) deducted in reporting the
related expense.
Supporters of the first method claim
that it is inappropriate to net income and
expense items and that separation of the
grant from the expense facilitates
comparison with other expenses not
affected by a grant. For the second
method it is argued that the expenses
might well not have been incurred by
the entity if the grant had not been
available and presentation of the
expense without offsetting the grant
may therefore be misleading.
Both methods are regarded as
acceptable for the presentation of grants
related to income. Disclosure of the
grant may be necessary for a proper
understanding of the financial
statements. Disclosure of the effect of
the grants on any item of income or
expense which is required to be
separately disclosed is usually
appropriate.
Repayment of Government Grants
A government grant that becomes
repayable shall be accounted for as a
revision to an accounting estimate (see
IAS 8, Accounting Policies, Changes
in Accounting Estimates and Errors).
For example:
l for grants related to income, the
amount of the repayment first
reduces any unamortised deferred
credit set up in respect of the grant,
or where no deferred credit remains
or exists, the repayment shall be
recognised as an expense
l for grants related to assets, the
repayment shall be recorded by
increasing the carrying amount of

the management accountant, August, 2009

the asset or reducing the deferred


income balance by the amount
repayable.
Forgivable loans
Forgivable loans from the
government are treated as government
grants when there is reasonable
assurance that the entity will meet the
terms for the forgiveness of the loan.
Non-monetary government grants
A government grant may take the
form of a transfer of a non-monetary
asset, such as land or other resources,
for the use of the entity. In these
circumstances it is usual to assess the
fair value of the non-monetary asset and
to account for both grant and asset at
that fair value. An alternative course
that is sometimes followed is to record
both asset and grant at a nominal
amount.
Government Assistance
Government grants do not include
certain forms of government assistance
which cannot reasonably have a value
placed upon them and transactions with
government which cannot be
distinguished from the normal trading
transactions of the entity.
Examples of assistance that cannot
reasonably have a value placed upon
them are free technical or marketing
advice and the provision of guarantees.
An example of assistance that cannot
be distinguished from the normal
trading transactions of the entity is a
government procurement policy that is
responsible for a portion of the entity's
sales.
The existence of the benefit might
be unquestioned but any attempt to
segregate the trading activities from
government assistance could well be
arbitrary.
The significance of the benefit in
the above examples may be such that
disclosure of the nature, extent and
duration of the assistance is necessary
in order that the financial statements
may not be misleading.
647

Accounting Issues

Loans at nil or low interest rates are


a form of government assistance, but
the benefit is not quantified by the
imputation of interest.
In this standard, government
assistance does not include the
provision of infrastructure by
improvement to the general transport
and communication network and the
supply of improved facilities such as
irrigation or water reticulation which is
available on an ongoing indeterminate
basis for the benefit of an entire local
community.
Prescribed Disclosures
Required disclosures include:
l the accounting policy adopted for

government grants, including the


methods of presentation adopted in
the financial statements
l the nature and extent of government
grants recognised in the financial
statements and an indication of other
forms of government assistance
from which the entity has directly
benefited
l unfulfilled conditions and other
contingencies attaching to
government assistance that has
been recognised.
Transitional Provisions
An entity adopting the standard for
the first time shall:
(a) comply with the disclosure
requirements, where appropriate;
and
(b) either: (i) adjust its financial
statements for the change in
accounting policy in accordance
with IAS 8, or (ii) apply the
accounting provisions of the
standard only to grants or portions
of grants becoming receivable or
repayable after the effective date of
the standard.
Contact information
SIC Interpretation
The Standards Interpretations
648

Committee (SIC) of the IASC has issued


the following Interpretation relating to
IAS 20:
l SIC 10, Government Assistance No Specific Relation to Operating
Activities (issued in July 1998,
effective from August 1, 1998)
In some countries, government
assistance to entities can be aimed at
encouragement or long-term support of
business activities either in certain
regions or industry sectors. Conditions
to receive such assistance may not be
specifically related to the operating
activities of the entity.
Examples of such assistance are
transfers of resources by governments
to entities which:
(a) operate in a particular industry;
(b) continue operating in recently
privatised industries; or
(c) start or continue to run their
business in underdeveloped areas.
The issue is whether such
government assistance is "a
government grant" within the scope of
IAS 20 and should therefore be
accounted for in accordance with this
Standard.
Under SIC 10, government
assistance to entities that is aimed at
encouragement or long-term support of
business activities either in certain
regions or industry sectors meets the
definition of government grants in IAS
20. Such grants should therefore not be
credited directly to shareholders'
interests.
This interpretation concerns the
treatment of government assistance
which is given to encourage or provide
long-term support to business activities
either in certain regions or industry
sectors. Although such assistance may
not be specifically related to the
operating activities of the entity, the
consensus was that it meets the
definition of government grants even
though there may be no conditions

other than a requirement to operate in


certain regions or industry sectors SIC
10 notes that such grants should not
be credited to equity.
Project to Reconsider IAS 20
This project had started as part of
the short-term convergence project of
the International Accounting Standards
Board (IASB) designed to eliminate a
variety of differences between IFRS and
US generally accepted accounting
principles (GAAP). However, the project
has evolved into a stand-alone (nonconvergence) IASB project to
reconsider IAS 20. In late 2005 the IASB
stated that the objective of the project
is to amend IAS 20 by applying the
accounting model for government
grants contained in IAS 41 to all
government grants. The IAS 41 model
establishes the following principles for
recognising grants related to assets
measured at fair value through profit and
loss:
l Recognise the grant when it
becomes receivable.
l Recognise income when conditions
attached to the grant have been met.
In July 2002 IASB Meeting, the IASB
believes that IAS 20 is out of date and
inconsistent with the Framework.
In the February 2004 IASB Meeting,
the staff presented two options,
namely:
l Amend IAS 20 to reflect the
requirements for government grants
contained in IAS 41
l Withdraw IAS 20 in its entirety
The staff recommended the second
option and that the Basis for
Conclusions should state:
l The standard has been withdrawn
because it is an impediment to
accounting for a government grant
in a manner that is consistent with
the Framework;
l The withdrawal is a temporary
measure, because the IASB is
addressing the accounting of

the management accountant, August, 2009

Accounting Issues

government grants as part of its


revenue recognition project;
l Entities should follow the
requirements in paragraphs 10-12 of
IAS 8 for developing an accounting
policy in the absence of specific
requirements.
The IASB decided that IAS 20
should be retained. The guidance in the
standard on accounting for government
grants should be removed and replaced
with the guidance from IAS 41. The IASB
decided the only amendment to the
guidance in IAS 41 should be to
withdraw the references to assets
measured at fair value. The IASB agreed
in principle that no further amendments
should be made until such time as the
revenue recognition project is
completed.
At the July 2004 IASB Meeting, the
previous decisions to replace the
provisions of IAS 20 with a standard
based on guidance for recognising
grants in IAS 41 were noted.
The staff noted that there was a
potential inconsistency between the
government grant liability measurement
and revenue recognition requirements
of IAS 41 and the proposed changes to
IAS 37 and the Revenue Recognition
project. The inconsistency relates to the
delay in revenue recognition under IAS
41 requirements until a specified
condition is satisfied at which time the
full grant is recognised in revenue.
The staff noted that IAS 41 refers to
conditional and unconditional grants
but does not provide sufficient
guidance on what is meant by
conditional in this context.
Recognition of government grant as
an asset or reduction of liability: The
staff recommended that an entity should
recognise a government grant as an
asset at the earlier of the entity:
l having an unconditional right to
receive the government grant
without conditions attached to its
retention; and

l receiving the government grant.

A number of Board members noted


that this was not their preferred solution
but agreed that further development is
outside the scope of the short-term
convergence project. After discussion
the IASB agreed not to provide
guidance on whether an asset and
liability would be recognised when a
repayment clause is attached to a
condition or whether no asset should
be recognised at all until the grant is
fully non-repayable.
Testing an asset for impairment: The
staff recommended that an asset
acquired in connection with a
government grant should be tested for
impairment on initial recognition. The
IASB agreed subject to adding
clarification that any liability recognised
in relation to the grant be considered as
part of the cash generating unit.
Loans at nil or low interest rates: The
staff recommended removing the
reference to these loans from the
proposed government grants standard
so that they would be accounted for
under IAS 39, Financial Instruments:
Recognition and Measurement. The
IASB agreed.
The IASB agreed to require
retrospective application except for the
impracticability exemption and to
request commentators to provide
details of circumstances where this
would not be possible.
In June 2005, the IASB withdrew
International Financial Reporting
Interpretations Committee (IFRIC)
Interpretation 3, Emission Rights. At
that time, it indicated that it intended to
address emission rights in a separate
exposure draft early in 2006.
Subsequently, in January 2006, the IASB
has determined that since emission
rights are a form of government grant,
they should be addressed in the project
to reconsider IAS 20.
At the February 2006 Meeting, the
IASB discussed the current status of

the management accountant, August, 2009

the project to revise IAS 20. In addition,


they discussed a request from the
national standard-setter in New Zealand
that IAS 20 be withdrawn.
Although some Board members
thought that withdrawing IAS 20 would
be a step in the right direction, the
majority thought that the accounting
vacuum that it would leave behind was
not desirable. Nor was the accounting
for grants in IAS 41 thought to be
necessarily superior.
The IASB noted that certain issues
related to recognising and measuring
obligations under grants with
conditions attached are similar to issues
related to recognising and measuring
provisions under IAS 37. Because the
IASB is currently reconsidering IAS 37
as part of the Business Combinations
Phase II project, it decided to defer work
on the IAS 20 project pending final
decisions on revision of IAS 37, which
are expected in mid-2007 (8 in favour; 6
opposed). This decision effectively
means that work on accounting for
emission trading schemes will also be
deferred.
In December 2007, the IASB agreed
to add to its agenda a project limited to
addressing the following key issues
related to Emission Rights Trading
Schemes:
1. Are the tradeable permits in
emission trading schemes
(allowances and credits) assets? If
so:
2. How should an entity account for
any allowances that it receives from
government for less than fair value?
3. How should allowances and credits
be accounted for?
4. How should changes in assets and
liabilities (arising from emission
trading schemes) be reported in
profit or loss?
The outcome of that project is not
expected to result in a new IFRS. Rather,
the IASB plans to address the issues
by:
649

Accounting Issues
l a revision of either IAS 38, Intangible

Assets or IAS 39 to accommodate


the accounting for tradeable
permits, and
l a revision of IAS 20 so that the
accounting for allowances (and
similar assets) issued by
governments free of charge is
addressed.
2008 Amendment - Improvements to
IAS 20
The IASB published on May 22,
2008, "Improvements to IFRSs 2008".
IAS 20 was amended based on this
project in the following areas:
l eliminating inconsistencies with the
Framework, in particular the
recognition of a deferred credit
when the entity has no liability; and
l eliminating options that can reduce
the comparability of financial
statements and understate the
assets controlled by an entity.
Next steps
The IASB has many reservations
about the requirements of IAS 20, in
particular:
l The recognition requirements of
IAS 20 often result in accounting
that is inconsistent with the
Framework. For example, the
requirement in paragraph 12 to
recognise grants 'as income over
the periods necessary to match them
with the related costs which they
are intended to compensate' can
result in an entity recognising an
amount in the statement of financial
position as a deferred credit when
the entity has no liability.
l As well as being inconsistent with
the Framework, the recognition
requirements of IAS 20 are also
inconsistent with more recent
pronouncements of standardsetting bodies relating to either nonreciprocal transfers in general or,
more specifically, government
grants. For example, the US Financial
Accounting Standards Board
650

(FASB) Statement No. 116,


Accounting for Contributions
Received and Contributions Made
(SFAS 116), whilst exempting
government grants to business
entities from its scope, provides an
accounting model that can be
applied to government grants and
that is consistent with the
Framework. In Australia, UIG
Abstract 11 Accounting for
contributions of, or contributions for
the acquisition of, non-current
assets, whilst specifying a different
treatment for contributions subject
to conditions than SFAS 116, is also
consistent with the Framework.
International Public Sector
Accounting Standard 23 Revenue
from Non-Exchange Transactions
(Taxes and Transfers) is also based
on principles that are consistent
with the Framework.
l IAS 20 contains numerous options.
For example, an entity that receives
a grant to finance the acquisition of
an item of property, plant or
equipment is entitled to deduct the
grant from the carrying amount of
that item, and an entity that receives
a non-monetary grant is permitted
to measure the asset and the grant
at a nominal amount rather than fair
value. In addition to reducing the
comparability of financial
statements, these particular options
in IAS 20 result in understatement
of the assets controlled by the entity
and do not provide the most
relevant information to users of
financial statements.
Distinguishing between unconditional and conditional grants
IAS 41 distinguishes between
unconditional and conditional grants.
An unconditional grant is recognised
as income when the grant becomes
receivable; a conditional grant when the
condition is satisfied. IAS 41, however,
contains little guidance about what is
meant by unconditional or conditional

in this context. Therefore the IASB


decided to define a condition for the
purposes of revised IAS 20 as a
stipulation that entitles government to
the return of the granted resources if a
specified event either occurs or does
not occur. The IASB also noted that any
such stipulation should have
commercial substance to be regarded
as a condition.
Recognition of grant as an asset or
as a reduction in a liability
IAS 41 specifies when a
government grant is recognised as
income. It does not specify when the
transfer of resources from government
is recognised. Therefore, the IASB
decided to specify that an entity should
recognise a government grant as an
asset at the earlier of (i) having an
unconditional right to receive the
government grant (regardless of
whether there are conditions attached
to retaining the grant) and (ii) receiving
the government grant. The IASB
decided that if the grant involves
government waiving repayment of all
or part of a liability, the reduction in
liability should be recognised when the
liability is discharged or cancelled.
Definition of a government grant
A government grant is defined in
IAS 20 as a transfer of resources "in
return for past or future compliance with
certain conditions relating to the
operating activities of the entity". The
IASB observed that in an accounting
model that distinguishes between
conditional and unconditional grants,
the use of the word 'conditions' in this
definition could be confusing.
Therefore, the IASB decided to delete
the phrase 'in return for past or future
compliance with certain conditions
relating to the operating activities of the
entity' from the definition of a
government grant. The IASB also
decided to provide additional guidance
in the amended Standard to clarify
which transactions with government
meet the definition of a grant.

the management accountant, August, 2009

Accounting Issues

Conflict with IAS 39


IAS 20 explains that loans at nil or
low interest rates are forms of
government assistance, but the benefit
of the reduced loan is not treated as a
government grant.
Similarly, a government may
guarantee an entity's borrowing, but
IAS 20 does not treat the benefit of the
guarantee as a government grant. The
IASB noted that these requirements of
IAS 20 conflict with IAS 39 because IAS
39 requires financial liabilities to be
measured initially at fair value.
Therefore, the IASB decided to delete
the references to loans at nil or low
interest rates and guarantees from
paragraphs 35 and 37 of IAS 20.
Impairment
The IASB decided that entities that

receive a government grant in


connection with the acquisition of an
asset should be required to test that
asset for impairment in accordance with
IAS 36, Impairment of Assets on its
initial recognition. The IASB also
decided to clarify that any recognised
liability arising from conditions
attaching to the grant should be
included in the same cash-generating
unit as the acquired asset.
Transition requirements for the
amendments to IAS 20
The IASB decided to propose
retrospective application in accordance
with IAS 8. However, it decided to ask
constituents to provide details of
circumstances in which this requirement
would cause difficulties.

Comparative Indian Standard


The Accounting Standard issued
by the Institute of Chartered
Accountants of India (ICAI)
comparative to IAS 20 is AS 12,
Accounting for Government Grants. AS
12 revised corresponding to IAS 20 has
been approved by the Council and the
NACAS. There is no difference between
the Draft of the standard and IAS 20.
Conclusion
The scope of the 'Emission Rights
Trading Schemes Project' addresses
only emission trading rights, including
any government grants associated with
such emission trading rights, but does
not address government grants more
generally. The IASB does not now have
a plan for comprehensive reconsideration of IAS 20.q

guidance need to be issued to recognize


certain methodologies or approaches to
evaluate transfer pricing of intangibles.
Advance Pricing Agreement
mechanism
Advance pricing agreement
mechanism is an agreement which is
reached in advance between the
assessee and the transfer pricing
authorities on transfer pricing strategy.
There is a necessity to have the advance
pricing agreement mechanism in the
transfer pricing regulations to minimize
long drawn litigations.
Penalties
The penalties of 100% to 300% for
concealment of income is extremely
harsh especially since the transfer
pricing decisions are extremely
subjective and also since the assessee
cannot validate his transfer pricing
strategy as there is no advance pricing
agreement mechanism in India. The
penalty structure needs to be toned
down and should be levied only in
exceptional cases.

Perspective LexisNexis 2007


Devasar Nitasha "TNCs and Transfer
Pricing in India Regulatory Strategies and
Corporate Strategies"
Jain R.K. "Customs Law Manual" Centax
Publications Pvt. Ltd.
Khilnani "Foreign Exchange Management
Manual" Volume 1 Snow White
Mittal D.P. "Taxmann's Law of Transfer
Pricing" 2nd Edition
OECD "Transfer Pricing Guidelines for
Multinational Enterprises and Tax
Administrations"
Ramaiya A "Guide to the Companies Act"
16th Edition Part 2 and Part 3
Report of the Expert Group on Transfer
Pricing Guidelines submitted to the
Government of India Ministry of Finance
and Company Affairs Department of
Company Affairs August 2002
Taxmann's Income Tax Act 2008
Taxmann's Income Tax Rules 2008
Wahi V.S. "Transfer Pricing Law Procedure
and Documentation Snow white 2004
Zobalia Hemal "Transfer Pricing"
www.business-standard.com
www.capitalmarket.com
www.incometaxindia.gov.in
www.internationaltaxreview.com
www.itatonline.org
www.taxindiaonline.com
www.thehindubusinessline.comq

Contd. from Page 644


approaches and avoiding controversies
and litigations it would be helpful if the
CBDT issues rules which would provide
the circumstances in which the tax
authorities would automatically accept
transfer prices. The rules could require
tax payers to establish transfer prices
as per a specific information reporting
and record maintenance provision with
regard to controlled transactions.
Confidentiality of information
Section 92D requires that sufficient
information
and
necessary
documentation in respect of the
international transaction have to be
maintained and furnished to the
Assessing Officers when required by
them. Since confidentiality of
information is important for the survival
of business, it must be provided that
such crucial information be allowed to
be retained by the assessee after
examination, verification and
authentication by the Assessing Officer.
Intangibles
Indian transfer pricing regulations
do not have a specific provision for
dealing with transfer pricing of
intangibles. All the five prescribed
methods are not found adequate in
dealing with the problem. Proper

References
Bhattacharyya Asish K. "Indian Accounting
Standards"
Butani Mukesh "Transfer Pricing An Indian

the management accountant, August, 2009

651

Issues in Management Accounting

Cost Accountant - Role in IFRS


Rammohan N Bhave*

ere is an attempt to highlight the


role of CMA in IFRS.
1. Present Role of CMA: While the
financial accounts are presented to
the outside world, the cost and
management accountants role is to
delve in-to depth.
Let us analyze this role
Member in Industry:
a) A CMA does the internal
profitability analysis
b) A CMA is the one who propogates
the real picture
c) In his/her MIS, he/she crosses the
legal structures and boundaries and
presents the picture to promoters
from their point of view.
d) CMA analyses costs taking into
consideration concepts like notional
cost, opportunity cost, sunk cost.
e) CMA is responsible for budgets and
budgetary control. CMA compares
budget with actual and carries out
variance analysis and presents a
transparent picture.
f) In a legal contract there are many
terms & conditions like price,
delivery, payments, taxes, add-on
products, services, warranty, AMC
i. In a purchase contract a CMA
presents a comparison of
alternative quotations by
calculating cost-to-company by
taking into consideration all
terms & conditions to make a
sensible choice in the group's
interest.
ii. In the sales contract he applies
the concept of total cost of
ownership (TCO) and helps in
making a competitive quote to
win the orders.
*CMA, CS, CA, LL.B. (G.) with 28 years
industrial experience in India and overseas.

652

g) Transfer Pricing (TP) within the


group and promoters' really
controlled entities, CMA is expected
to achieve stakeholders (?) interests
to maximize overall group gains.
h) In a globalized scenario he plays a
pivotal role in making justified
valuations by giving due weightage
to brand, human assets, patent,
trade-marks etc. intangible assets.
Members in Practice:
a. The cost accounting records are
viewed from the need for
transparency.
b. The cost audit is carried out to
address lot of techno-commercial
business issues and valuable cost
reduction suggestions through out
of the box thinking.
c. The CMA in Practice also brings on
table the benchmark experiences in
order to bring in fair value principles
and the active market comparisons.
d. The depreciation and impairment
based on useful life are considered
for effective costing in the
managerial decisions.
2. Spirit of IFRS:
a. IFRS transparently bring out the real
beneficiaries.
b. IFRS advocate and makes substance
compulsory over form.
c. IFRS ensure consolidation with
principles based transfer pricing.
d. IFRS want borrowing cost in terms
of e.g. extended terms of credit to
be classified as finance cost.
e. IFRS use market price concept for
right valuations.
f. IFRS valuations under business
combinations always demand fair
value assessment.
g. IFRS depreciate assets on useful life
and thereby promote uses of real

cost drivers.
h. IFRS expect constant reviews at
every reporting period to be in touch
with reality.
i. IFRS provide forty types of
intangible assets.
j. IFRS avoid extra-ordinary items
which vitiate the balance sheet.
k. IFRS insist on showing surplus fund
by different classifications to reflect
its reality.
Linkages: IFRS and CMA:
1. The above description makes it clear
and the vital synergies are ;
a) CMA goes for reality, IFRS is also
in search of truth
b) CMA creates link to real cost
natures by using cost drivers
concept, IFRS propagates the same.
c) In the global scenario CMA works
upon in-depth valuations of cross
border acquisitions, IFRS is full of
valuations and valuations.
2. The basic questions before CMA
professionals are therefore :
a) Does the CMA want to become a
torch-bearer of global transparent
accountings dealing with real
costing thru fair value or to remain
as he was, a Cost Accountant doing
cost-sheet (treating wages as fixed
costs even today)?
b) Does the CMA want to enhance
their expertise to analyze
transparency in variance with 2 prior
years accounts displayed to
shareholders or to remain in cost
audits which is yet to gain
acceptability despite being useful.,
c) Does the CMA want to become a
role model of Global costing
Principles rather than to carry out
profile of correction of BOM in SAP
as a clerk?
d) Does the CMA want to be a
godfather of 'Substance Over Form'
in the revolution of corporate history
in annual statements ?q

the management accountant, August, 2009

Budget analysis

Budget 2009 :
Expenditure of Rs. 10.21
lac crores analysed
Dr. V. M. Govilkar*

he Budget Estimates 2009-10


provide for a total expenditure
of Rs.10,20,838 crores.. is
the statement made by the Hon. Finance
Minister in para 74 of his budget
speech. He also referred to the
expenditure of only Rs. 193 crores in
the first budget of the central
government after independence. The
fact that the budgeted expenditure
exceeding the level of Rs. 10 lac crores
is underlined by the Minister. Here is
an attempt to know and analyse the
proposed expenditure.
Three roles of the government in the
economy
Any government is supposed to
play three types of role in the economy
viz.
1. Police state : This role involves
protecting the country from outside
attacks and maintaining law and
order in the country. The govt. has
to spend on defence, police, court
and administration.
2. Development state : It is the primary
responsibility of every govt. to
ensure the development of the
economy. Creating infrastructure
facilities like roads, electricity,
irrigation, communication, transport,
banking, insurance etc is necessary
for economic development. The
govt has to spend on this so that
the industry, trade, service sector
and agriculture develop.
3. Welfare sate : The govt has to spend
to deepen and broaden the process
of inclusive growth and to ensure
M. Com., LL.B., F.C.A., Ph.D. vgovilkar
@rediffmail.com

that no individual, community or


region is denied the opportunity to
participate in and benefit from the
development process.
Indian government too, like any
other govt., has to perform these roles
and therefore needs to spend on them.
Unique situation in 2009
In addition to the above, this year,
the govt spending was expected to be
more because of the special condition
of the global recessionary trends. The
fiscal crises of US economy came to
forefront in September 2008 and within
a very short time, became the economic
problem. It did not remain the worry of
only US economy, but spread the world
over. All the countries in the world
started experiencing the recession, to
say the least, the economic slowdown .
India, too, noted the reduction in the
rate of growth from about 9% to 6.7%.
The Finance Minister had the challenge
to lead the economy back to the high
GDP growth rate of 9% p.a. at the
earliest. To achieve this goal, the
demand in the economy was required
to be pushed up by increasing the
purchasing power of the people. As was
advocated by the noted economist
Mr.Keynes during the period of great
depression of 1930s, the govt has to
resort to 'pump priming' i.e. pumping
money in the economy by increasing
govt expenditure.
The Budget proposals
The Finance Minister, in 2009
budget, announced a number of
measures to provide fiscal stimulus. The
main focus is on creating and improving
infrastructure. The allocation for
National Highways Development
Programme is stepped up by 23%, for

the management accountant, August, 2009

railways by 50% [Rs.15800 crores], for


Jawaharlal Nehru National Urban
Renewal Mission by 87% [Rs.12887
crores], for The Accelerated Power
Development and Reforms Programme
by 160% [Rs.2080 crores],.Huge
spending by govt on infrastructure not
only creates basic facilities, but also
gives momentum to the private sector
activities, generates employment and
ensures purchasing power in the hands
of people which ultimately creates
demand and the economy comes out of
slow down.
The budget proposes an allocation
of Rs.45356 crores [45% increase] on
account of Bharat Nirman and Rs.62230
crores for major eight schemes of rural
development and welfare. National Rural
Employment Guarantee Scheme has got
Rs.39100 crores which is 144% more as
compared to the last year.
In short, the Budget has increased
expenditure to fulfill its role as
development state and also the welfare
state. This considerable amount
proposed to be spent is expected to
create demand and thereby help find
way in economic slowdown by reviving
demand in the market.
Analysis of the expenditure
The expenditure of Rs. 10.21 lac
crores can thus be justified. However, if
we analyse the details of this
expenditure, some interesting
conclusions follow. They are presented
below1. The five heads : In the expenditure
budget, we find five heads viz.
interest on govt borrowings,
defence, subsidies, police and
pension. All the five expenses are
essential and unavoidable but at the
same time, it should be agreed that,
they are unproductive. In 2009
budget, the estimated expenditure
on these heads is Rs.438860 crores.
It amounts to almost 43 % of the
total expenditure, 71.5 % of total
revenue receipts and 92.54 % of tax
revenue. It goes without saying that
a very small portion is then left for
productive expenditure.
653

Budget analysis

2. Debt servicing : The interest on


loans and instalment of loan
repayment is termed as debt
servicing. In the budget 2009, these
figures are Rs.2,25,511 crores and
Rs.3,42,891 crores respy. In other
words, the amount necessary for
debt servicing is Rs.5,68,402 crores,
which is about 56% of the total
expenditure. It is interesting to note
that this amount exceeds total
expected tax collection by 20% i.e.
by Rs. 94,200 crores. Is the debt and
revenue position of govt
satisfactory ?
3. Capital expenditure : The capital
expenditure helps the govt create
assets which will yield revenue to
the govt. in years to come. Hence
the amount of capital expenditure
should be an important criterion for
analyzing the budget expenditure.
In the budget 2009, the capital
expenditure [ excluding defence
capital expenditure] is only
Rs.68,782 crores. In the total
expenditure of Rs.10.21 lac crores,
capital expenditure is hardly 6.7%.
Wih such a negligible spending on
capital expenditure,can anybody
name it a development budget ?
4. Plan Expenditure : India adopted
planning as the policy for
development. The five years plans
chalk out the path for development
and the funds to implement the plan
are to be allocated through budget.
Obviously, the more the plan
expenditure, better and faster are the
chances of development. In budget
2009, the total plan expenditure is
Rs. 3,25,149 crores only which
amounts to 32%. If the revenue plan
expenditure is excluded, the capital
plan expenditure is as less as
Rs.46,751 crores only. How can one
expect to achieve fast development
with a meagre 4.6% of total
expenditure?
5. Aam Aadami : It said that the2009
budget is for 'aam aadmi' and it
focuses on agriculture. The Finance
Minister said that he wanted to
654

restore agriculture growth at 4 %.For


achieving this, he has allocated
Rs.10,060 crores in 2009 budget to
the Ministry of Agriculture which
are more by Rs. 100 crores only than
2008 budget. This amount is just 1
% of the total budgeted expenditure.
The allocation for consumer affairs,
food and public distribution is only
Rs. 440 crores up by Rs. 86 crores
only. The Ministry of food
processing has got Rs.340 crores
which amount is more by Rs.50
crores only than budget 2008.The
allocation to the Ministry of micro,
small and medium enterprises got
Rs.1864 crores , Rs.10 crores extra
as compared to 2008 budget. The
allocation for the Ministry of
Housing And Urban Poverty
Alleviation has gone down from
Rs.Rs.8,620 crores [2008 budget] to
Rs. 7,580 crores only.Do we find
urge for aam aadmi in these
allocations ?
6. Reduction in the allocation : The
contribution of service sector in the
GDP was about 55 % in the recent
past
and
IT
alongwith
communication sector had a major
part in the same. On this background
, it is surprising to note that the
budget 2009 has allocated Rs.19,638
crores to The Ministry of
Communication and Information
Technology which is less by
Rs.4,349 crores as compared to 2008
budget. In the era of curbing
outsourcing by developed countries
in IT sector, will this reduction in
allocation be justifiable ?
7. Expenditure on economic services :
Agriculture, industry, power,
transport, communication, science
and technology etc are termed as
economic services. These services
, needless to say, play an important
role in the economic development
of the country. The total revenue
expenditure on these services in
2009 budget is only Rs. 23,840 crores
i.e. 2.3 % of the total expenditure. Is
this spending satisfactory for the
pace of development planned ?

8. Borrowings : The total expenditure


budgeted is of Rs. 10,20,838 crores.
To meet this expenditure, the budget
proposes to borrow Rs. 4,00,100
crores. Thus the borrowed funds are
about 40 % of the spending. This
huge amount borrowings will lead
to increase in the rate of interest in
the market and ultimately to
inflationary trend. It will further
worsen the fiscal position in years
to come as the amount of interest
will go up and the repayment burden
will also increase.
More spending with huge borrowing
without proper allocating
After analyzing the expenditure of
the 2009 budget, one can summarise the
discussion asl There is justification for huge
spending on the part of the
government as the govt has to
protect the country, achieve the
development, and ensure the
welfare of the people. Further, at
present ,to minimize the period of
slow down and to restore the growth
rate increased government spending
may be necessary.
l Taking into account the interest
burden and debt servicing
obligation, the huge borrowings
proposed for the spending certainly
needs reconsideration. It has
completely
neglected
the
responsibilities laid down
mandatorily by the Fiscal
Responsibility and Budget
Management Act.
l The allocation of funds for various
purposes and to different ministries
should have been done with more
wisdom.
l The ever increasing expenses on
account of interest, defence,
subsidies, pension and police leave
in the hands of government, a very
small amount for development of the
economy and welfare of the people.
Efforts are needed to reverse the
trend.q

the management accountant, August, 2009

Legal update

Is UCP 600 solution to


Letters of Credit problems?
It is generally accepted that international trade transactions carry inherently
more risk than domestic trade transactions, because of differences in culture,
business processes, laws and regulations prevalent in various countries. A letter
of credit is a very common and important instrument in settling trade between
nations. Buyers and sellers negotiate for purchase and sale of goods, sellers
demanding cash or buyers' banker's letter of credit as guarantee for payment
before they undertake shipment. A letter of credit adds buyer's integrity through
banker's guarantee for the payment. It is therefore important for traders to ensure
that payment is received by the exporter for the goods dispatched by him and
that the goods received and paid after complying with the terms of contract of
sale. One effective way of managing these risks has been for traders to rely on the
letter of credit as a payment method. However for exporters in particular, the
letter of credit has presented difficulties in meeting the compliance requirements
necessary for the payment to be made. The current rules that govern letter of
credit transactions are regulated by an updated set of rules (UCP 600), which
have been introduced on 1 July 2007. This paper will make the readers to
understand the term of Letters of Credit and procedure thereof, Documentary
Credit, changes mooted by UCP 600 vis--vis UCP 500. A gist of important
Articles governing letters of Credit set under UCP 600.

J. K. Budhiraja
Introduction
efore we examine whether UCP
600 is a solution to Letters of
Credit problems, it is pertinent
that we should have some background
to the letters of credit. Letters of credit
have been described "as the lifeblood
of international trade and commerce".
It is generally accepted that international trade transactions carry
inherently more risk than domestic trade
transactions, because of differences in
culture, business processes, laws and
regulations prevalent in various
countries. A letter of credit is a very
common and important instrument in
settling trade between nations. Buyers
and sellers negotiate for purchase and
sale of goods, sellers demanding cash
or buyers' banker's letter of credit as
guarantee for payment before they
undertake shipment. A letter of credit
adds buyer's integrity through banker's
guarantee for the payment.

FICWA, FCS

A documentary credit is a signed


instrument embodying an undertaking
by the buyer's bankers to pay seller a
certain sum of money on presentation
of documents evidencing shipment of
specified goods though after
compliance of stipulated terms and
condition of documentary credit. In this
case bankers have to see only
compliance with respect to terms and
conditions of documentary credit and
physical receipt of goods by buyer is
not necessary before making payment
against the documentary credit. Thus
Banks accept the documents under
letters of credit for what those
documents appear to be on their face.
Types of Letters of Credit
Letters of Credit may be back-to-back
(countervailing), clean or documentary,
confirmed or unconfirmed, fixed or
revolving, revocable or irrevocable,
sight or acceptance, transferable or
divisible and with or without recourse.
The Revocable letters of credit allow the

the management accountant, August, 2009

document and the clauses to be


changed without the agreement of the
exporter, whereas irrevocable letters of
credit, once issued, require the
agreement of the exporter before any
changes can be incorporated. The
irrevocable credit, therefore, provides a
higher degree of payment security for
the exporters.
The seller may require that the letters
of credit to be confirmed by a bank of
his own country as he may be unaware
of the standing of the opening bank or
he may like to seek additional protection
of his interest. In such cases, the
opening
bank
requests
its
correspondent in the seller's country to
add its confirmation which in effect
means that the confirming bank
undertakes the liability to honour the
seller's drafts drawn under the credit.
Under the Sight Letters of Credit,
the amount is payable as soon as the
prescribed documents have been
presented and the bank has checked
them. Therefore, in sight letters of
credit, the payment is immediate to seller
after compliance of terms and
conditions of letters of credit. In case
of Deferred Letters of Credit, the
payment is not made immediately upon
presentation of the documents, but only
after a period of time specified in the
credit. For example, payment will be
made by bank after a period of 90 days
from the date of receipt of the goods
covered under the terms of letters of
credit.
How Does the Letter of Credit Process
Work?
l The seller (known in the Letter of

Credit as the "Beneficiary") advises


the buyer (known in the Letter of
Credit as the "Applicant") that the
purchase order is acceptable. The
Beneficiary also sends the
Applicant a copy of their "Letter of
Credit Guidelines" to ensure that the
credit is opened properly and will
not require any costly amendments.
655

Legal update
l A Letter of Credit Application is

completed by the Applicant and is


submitted to their Bank (say Punjab
National Bank, the Opening Bank).
The Letter of Credit is issued and
sent by the Opening Bank to an
Advising Bank in the country of the
Beneficiary. The main role of an
advising bank is to check the
authenticity of the Letter of Credit
before it is advised to the
Beneficiary.
The Advising Bank then sends a
copy of the Letter of Credit to the
Beneficiary, either electronically, by
fax, or by mail.
The Beneficiary must now carefully
review the requirements of the Letter
of Credit to ensure it has been
issued per the agreed terms. The
Beneficiary should make sure that
they can comply with all stipulations,
such as shipping terms,
documentary
requirements,
shipping and/or expiration dates
and packing and marking
conditions.
If the Letter of Credit has terms that
are not per the agreement, the
Beneficiary should request an
amendment to the Letter of Credit.
This request is made directly to the
Applicant, who then instructs the
Opening Bank to amend the Letter
of Credit.
Once the Letter of Credit is in order
and the shipment is ready for export,
the Beneficiary ships the goods to
the freight forwarder.
The seller (or third party, such as
LC Solutions) can now begin
preparation of documentation
required under the Letter of Credit
terms.
After goods have shipped, the
transport document is acquired by
the Beneficiary (or LC Solutions), is
checked for accuracy, matched up
with other created documentation,
and presented to the Negotiating

656

Bank. (The Negotiating Bank may


or may not be the same as the
Advising Bank, depending on the
requirements of the Letter of Credit
and the wishes of the Beneficiary.)
l The Negotiating Bank checks over
the documentation and advises any
problems they may find with the
paperwork. They then either issue
payment to the Beneficiary, or
forward the documents to the
Opening Bank for payment,
depending on the terms of the
Letter of Credit.
Uniform Customs and Practice (UCP)
for Documentary Credits
The letters of credit are governed
by standard rules and practices known
as "Uniform Customs and Practices"UCP. The UCP is the work of the ICC
(International Chamber of Commerce),
a private international organization
founded in 1919 and is formulated
entirely by experts in the private sector.
To date, it remains the most successful
set of private rules for trade ever
developed.

UCP 600 represents the sixth


revision of the Uniform Customs and
Practice for Documentary Credits (the
"UCP"), since its inception by the ICC
in 1933.
Previous publications:
UCP Publication Number 500, 1993
Revision.
UCP Publication Number 400, 1983
revision
UCP Publication Number 290, 1974
revision
UCP Publication Number 222, 1962
revision.
UCP Publication number 151, 1951
revision.
UCP Publication number 82 created
in 1933.
Flow Chart of Letters of Credit
Flow Chart is given in Fig. 1 below.
Important Changes introduced under
UCP 600 vis--vis UCP 500
The UCP 600 introduced the
following important changes to the UCP
500, which remain valid until June 30,
2007.

Flow Chart of letters of Credit


Issu es L e tter o f C red it

C h e cks D o cu m ents an d p ay s if co nfirm ed o r


p asses d o c u m e n ts to o pen in g B ank fo r p a y m ent
L C solu tion p rese nts c lean
d ocu m en ts to N ego tiatin g B an k
o r to A dv ising B an k

E x p orter fo rw ard s do cu m ents


an d letter of cred it to L C
so lu tio n s
L /C term s ag reed u po n b etw e e n
b uy er a nd seller
C o n tract/P u rchase O rd er

Fig.1
the management accountant, August, 2009

Legal update

(i)

Confirmation that the revised


guidelines are now to be treated
as rules.
(ii) The language is now more simpler,
precise and objective.
(iii) Now there are 39 articles instead
of 49.
(iv) Introduction of an article (Article
2) that contains exclusively
definitions of the terms used in the
rules,
thereby
avoiding
repetitions.
(v) Introduction of an article (Article
3) that contains exclusively
interpretations of terms. Words
like "honour", "negotiation",
"compliance" would be more
clearly understood now than ever
before.
(vi) It was clear in past also that all
parties including Banks deal only
with documents and not with
goods, services and performance.
However, UCP 600 has provided
more clarity on this aspect now.
(vii) The liability of issuing bank has
been defined more exactly than
ever before.
(viii) The timeframe that banks have for
examining documents has been
reduced from seven to five days,
starting from the day after the
documents are received.
(ix) The phrase "reasonable time" has
been removed. The procedure for
banks when refusing documents
("notice of refusal") has been
amended to correspond with
current practice and is more
precisely worded.
(x) The term "negotiation" that was
not defined in UCP 500 causing
difficulties in interpretation and
provoking a so-called position
paper, is now defined in Article 2.
(xi) Another new feature included in
the rules covers the frequent
practice of involving a third bank,
the so-called second advising

bank, as an intermediary between


the opening bank and the
beneficiary. The role of such a
bank is now also described in the
rules.
(xii) Advances against deferred
payments, another current practice
that occurs frequently and in effect
amounts to an early liquidation of
a debt, is also considered in the
rules. The rules stipulate that a
bank that has entered into such a
deferred payment obligation may
prematurely fulfill that obligation.
Similarly, the option to discount
accepted bills of exchange is also
taken into account.
(xiii) The rules attempt to call a halt to
the temptation for opening banks
and buyers to refuse documents
by using arguments relating to
discrepancies in or between the
documents (e.g. that "LLP" is not
the same as "Ltd", etc.). Wording
has been introduced to allow that
the information need not be
absolutely identical provided it is
not contradictory.
(xiv) The risk of documents being lost
is now transferred to the buyer in
certain circumstances.
(xv) The articles relating to
transportation documents have
been revised and reworded to
correspond better to current
practice. The clause stating that
goods could not be transported on
sailing vessels has been removed.
(xvi) The phrase "reasonable time" for
acceptance or refusal of
documents has been replaced by
a firm period of five banking days.
The differences between UCP 500
and UCP 600 as described above form a
short summary of the most important
points that differentiate the new rules
from the old. However, space does not
permit to elaborate the smaller changes
in this context. It is felt that the material
provided in the article will provide

the management accountant, August, 2009

sufficient insight to readers on


requirements relating to letters of credit
vis--vis UCP 600 latest rules governing
the letters of credit
Gist for some important Articles under
UCP 600
1. Nominated Bank: Article 2 of UCP
600 defines nominated bank
"Nominated bank means the bank
with which the credit is available or
any bank in the case of a credit
available with any bank."
Where a credit is available with a
nominated bank, the presentation of
documents by or on behalf of the
beneficiary will typically be made to that
nominated bank, however, documents
may be presented directly to an issuing
bank.
Any type of letters of credit may be
made available with a nominated bank.
A Nominated Bank is to pay, incur a
deferred payment undertaking, accept
a draft or negotiate, an issuing bank
authorizes that nominated bank to
honour or negotiate upon receipt of a
complying presentation. A nominated
bank is under no obligation to honour
or negotiate unless it has added its
confirmation to the credit or it has
expressly communicated to the
beneficiary its agreement to honour or
negotiate. Where a nominated bank
honours or negotiates under a
complying presentation, an issuing
bank undertakes to reimburse them.
2. Honour: UCP 600 article 2 defines,
Honour means: To pay at sight if
the credit is available by sight
payment, to incur a deferred
payment undertaking and pay at
maturity if the credit is available by
deferred payment, to accept a bill of
exchange ("draft") drawn by the
beneficiary and pay at maturity if the
credit is available by acceptance.
3. Confirmation and Confirming Bank:
Confirming Bank - honours or
negotiates. Confirming Bank is
irrevocably bound to honour or
657

Legal update

negotiate as of time it adds


confirmation for Reimbursement due
whether or not Draft or undertaking
purchased or prepaid.
4. Presentation: As per UCP 600 subarticle 14 (a): A nominated bank
acting on its nomination, a
confirming bank, if any, and the
issuing bank must examine a
presentation to determine, on the
basis of the documents alone,
whether or not the documents
appear on their face to constitute a
complying presentation. As per
sub-article 14 (c): A presentation
including one or more original
transport documents subject to
articles 19, 20, 21, 22, 23, 24 or 25
must be made by or on behalf of the
beneficiary not later than 21
calendar days after the date of
shipment as described in these rules,
but in any event not later than the
expiry date of the credit.
5. Complying Presentation: A
complying presentation is defined
in article 2 of UCP 600, which means:
a presentation that is in accordance
with the terms and conditions of the
credit, the applicable provisions of
these rules and international
standard banking practice.
It should be noted that reference in
this definition to "international standard
banking practice" is not confined to the
practices detailed in the ICC Publication
of the same name.
By inclusion in sub-article 14 (a) of
the reference to "appear on their face",
it is now deemed that there is no need
for similar reference in the articles
covering transport, insurance or
commercial invoice as was the case in
UCP 500.
The document checker must decide
on the basis of the documents alone
whether or not the documents
constitute a complying presentation.
For example: The actual quality of
goods received by the applicant may
not be same as defined in the Letters of
658

Credit but that is not a consideration


for the document checker, who must
determine compliance based on the
documents alone as stated in sub-article
14 (a) of UCP 600. This point is
emphasized by article 5 of UCP 600
which makes it clear that banks deal with
documents and not with goods,
services or performance to which the
documents may relate.
6. Banking Days: An issuing bank, a
confirming bank or a nominated bank
acting on its nomination, each have
to examine the documents and
determine if the presentation
complies in maximum number of
days 5 banking days following the
day of presentation. The time
allowed under UCP 500 was 7
banking days instead of 5 banking
days as above.
7. Date of Issuance: UCP 600 subarticle14 (i) makes it clear that
documents may be dated prior to
the issuance date of the credit, but
must not be dated later than its date
of presentation.
For example: Date of Issue: 07th July,
2009
Date of Presentation: 25th July, 2009
Date of Invoice: 1st July, 2009
Date of Packing List: 27th July, 2009
In the above presentation the
invoice is dated prior to the issuance
date but the packing list is dated after
the date of presentation. The invoice
complies with sub-article 14 (i). The
packing list does not. In simple terms, a
document may be dated any date upto
and including the date of its
presentation.
Article 15(b) states when a
confirming bank determines that a
presentation is complying, it must
honour or negotiate and forward the
documents to the issuing bank.
8. Contact Details: In the past,
document checkers have examined
documents to determine that contact

information such as telefax,


telephone and email addresses are
in compliance with those stated in
the credit. However, UCP 600 subarticle 14 (j) removed the need to
review contact information by
expressly stating that contact details
shown as part of the beneficiary or
applicant addresses in the credit will
be disregarded.
9. Discrepant Documents, Waiver and
Notice: Article 16 of UCP 600
provides that when a bank
determines that the documents do
not comply, it may refuse to honour
or negotiate. The issuing bank
having determined that a
presentation does not comply may:
(a) provide a notice of refusal to the
presenter (b) it may decide, in its
sole judgement, to contact the
applicant for a waiver of the
discrepancies - subject to the
presenter having not provided any
instructions to the contrary.
10. Notice of Refusal: When a bank
decides to refuse to honour or
negotiate, the creation and content
of its notice of refusal are of critical
importance. Sub-article 16 (c)
provides, banks with specific
direction as to the required content
of a notice of refusal. The notice
must state: (a) that the bank is
refusing to honour or negotiate (b)
each discrepancy in respect of
which the bank refuses to honour
or negotiate. There are 4 options
provided in sub-article 16 (c) in
relation to the status of the
documents: (a) that the bank is
holding the documents pending
further instructions from the
presenter (b) that the issuing bank
is holding the documents until it
receives a waiver from the applicant
and agrees to accept it or receives
further instructions from the
presenter prior to agreeing to accept
a waiver (c) that the bank is returning
the documents (d) that the bank is

the management accountant, August, 2009

Legal update

acting in accordance with


instructions previously received
from the presenter.
UCP 600 sub-article 16 (f) provides,
if an issuing bank or a confirming
bank fails to act in accordance with
the provisions of this article, it shall
be precluded from claiming that the
documents do not constitute a
complying presentation.
11. Bill of Lading: UCP 600 sub-article
20 (a) states that when a credit calls
for a bill of lading, a bill of lading is
acceptable 'however' named. For
example, if the credit calls for an
Ocean Bill of Lading and the
document presented is named
Airways Bill then it will be non
compliance and Bankers may refuse
to accept the documents unless
specific waiver is given by the
applicant. While examining the bill
of lading, the name of the carrier
must appear to be indicated. The
name of the carrier may be stated as
a separate statement on the bill of
lading i.e. "K- Line - the Carrier" or
in the manner the bill of lading is
signed i.e. "For K-Line - the Carrier".
The bill of lading must appear to
have been signed by the carrier or
the master, or a named agent acting
for or on behalf of the carrier or
master.
12. Port of Loading: The port of loading
in a bill of lading should be the same
as that stated in the credit. It can
happen that the bill of lading
evidences a port of loading that is
not the same as that indicated in the
credit or has a qualification such as
"intended port of loading". In this
event, the bill of lading must contain
an on board notation which includes
the port of loading indicated in the
credit, the date of shipment and the
name of the vessel.
13. Documents in Original: Bills of
lading are issued in sets of one or
more originals - usually 3. UCP 600
sub-article 20 (a) (iv) states that if

the credit calls for a bill of lading


then the bill of lading presented
must be the sole original bill of lading
or, if issued in more than one
original, be the full set as indicated
on the bill of lading.
14. Transhipment: During a port-to-port
shipment, transhipment will often
occur. UCP 600 sub-article 20 (b),
for the purpose of this article,
transhipment means unloading from
one vessel and reloading to another
vessel during the carriage from the
port of loading to the port of
discharge stated in the credit.
Generally, credits will indicate
whether transhipment is allowed or
not. If a credit does not contain any
condition in relation to
transhipment, then transhipment is
allowed. Even if a credit prohibits
transhipment a bill of lading
indicating that transhipment will or
may take place is acceptable,
provided the bill of lading indicates
that the goods have been shipped
in containers, trailers or LASH
barges. However, clauses in a bill of
lading stating that carrier reserves
the right to transhipment will be
disregarded.
15. Road, Rail or Inland Waterway
Transport Document: Article
24(e)(i) and (ii): (a) A road, rail or
inland waterway transport
document may indicate that the
goods will or may be transhipped
provided that the entire carriage is
covered by one and the same
transport document. (b) A road, rail
or inland waterway transport
document
indicating
that
transhipment will or may take place
is acceptable, even if the credit
prohibits transhipment.
15. Clean Transport Documents: As per
UCP 600 Article 27, a bank will only
accept a clean transport document;
the word "clean" need not appear
on a transport document due to
definition of complying presentation.

the management accountant, August, 2009

16. Insurance: Three different types of


insurance documents are typically
issued to cover the risks of goods
being lost, damaged or stolen
during international transport, these
are: (i) Insurance policies (ii)
Insurance certificates and (iii)
Declarations under open cover.
While checking these documents
under credits to establish
compliance, document checkers will
refer to article 28 of UCP 600. Article
28 of UCP 600 - Insurance
Documents and Coverage which is
an amalgamation of articles 34, 35
and 26 of UCP 500. As in the case of
transport documents, insurance
documents can be issued in one or
more originals. Sub-article 28 (c) of
UCP 600 makes it clear that cover
notes will not be accepted by banks
under a credit. UCP 600 sub-article
28 (d) an insurance policy is
acceptable in lieu of an insurance
certificate or a declaration under an
open cover.
17. Disclaimer on Transmission and
Translation: As per UCP 600 Article
35, If a nominated bank determines
that a presentation is complying and
forwards the documents to the
issuing bank or confirming bank,
whether or not the nominated bank
has honoured or negotiated, an
issuing bank or confirming bank
must honour or negotiate, or
reimburse that nominated bank,
even when the documents have
been lost in transit between the
nominated bank and the issuing
bank or confirming bank, or between
the confirming bank and the issuing
bank.
Conclusion
Now the question arises whether
UCP 600 is solution to Letters of Credit
problems. The letter of credit continues
to remain an important instrument of
finance that is particularly suited to
international business transactions and
it is vital that the rules that govern such
Contd. on Page 662
659

Institute Notification

Kolkata, the 19th June, 2009


NOTIFICATION
11-CWR (414- 420)/2009) : In pursuance of sub Regulation (3) of Regulation 11 of the Cost and Works Accountants
Regulations, 1959, it is hereby notified thai the Certificates of Practice grunted to :
1. Shri George Joseph, MCOM, LLB, AICWA, Anugraha Puthenpurayil, Near Caris Bhavan, Dist: kottayam,
Athinampuzha 680563, (Membership No. 23735) is cancelled from 15th January, 2009 to 30th June, 2009 at his own
request.
2. Mrs. Rujuta Anand Likhite, BCOM, AICWA, G-3, 312, Malhar, Lokpuram, Smt. Gladys Alvares Road, Opp. Pokhran
Road II, Thane (W) - 400610, (Membership No. 23267) is cancelled from 17th November, 2008 to 30th June, 2009 at her
own request.
3. Shri Shaibal Kumar Ukil, BSC, AICWA, Harinarayan Nagar, durgamandap Road, Barmasia, Dhanbad - 826001, (Membership
NO. 24539) is cancelled from 15th April, 2009 to 30th June, 2009 at his own request.
4. Shri K. N. Bhavani Shankar, BCOM, AICWA, No. 3, Bihag Apartments, 13, Street, Kalyani Nagar, Pune -411006, (Membership
No. 6207) is cancelled from 1st April, 2009 to 30th June, 2009 at his own request.
5. Shri Mukesh Garg, BCOM, AICWA, H. no. 880 A/18, Ghanipura, Rohtak - 124 001, (Membership No. 24110) is
cancelled from 20th May, 2009 to 30th June, 2009 at his own request.
6. Shri K. B. Pawar, BCOM, FICWA, A-4 12, Manavkalyan, Bangur Nagar, Goregaon (W), Mumbai - 400 090,
(Membership No. 4468) is cancelled from 1st April, 2009 to 30th June, 2009 at his own request.
7. Shri Nitin Agarwal, BCOM, AICWA, 11C & D, First Floor, Main Road Chirag, New Delhi -110 017, (Membership No.
18643) is cancclled from 25th April, 2009 to 30th June, 2009 at his own request.
Sd/(Kunal Banerjee)
President
Kolkata, 2nd July, 2009
NOTIFICATION
16-CWR (8695-8720)/2009: In pursuance of Regulation 16 of the Cost and Works Accountants Regulations, 1959, it is hereby
notified that in exercise of powers conferred by sub-section (I) (a) of Section 20 of the Cost and Works Accountants Act.
1959, the Council of the Institute of Cost and Works Accountants of India has removed from the Register of Members, the
names of :
1. Shri D. J. Doshi, BCOM, A1CWA, 6, Girish Apartment, Kalyan Road, Gopal Nagar 2, Opp. Janki Hotel. Dombivli - East 421201 (Membership No. 3898) with effect from 20th January, 2007.
2. Shri Mayur Dolatray Dave, BA, BCOM, AICWA, D/2, Nirman Park, Rajmata Jijabai Road, Pump-House, Andheri - (East),
Mumbai - 400093 (Membership No. 872) with effect from 1st December, 2008.
3. Shri Virendra Kumar Jain, MCOM, LLB, FICWA 8/1, Lal Bazar Street, Bikaner Building, 3rd Floor, Kolkata 700001
(Membership No. 2196) with effect from 23rd January, 2009.
4. Shri Haradhan Banerjee, MCOM, LLB, ACS, AICWA, General Manager - Finance & Company Secretary, Metro Dairy
Ltd., 21, Gopal Mukherjee Road, Kolkata -700002 (Membership No. 5040) with effect from 25th December, 1999.
5. Shri N. M. Vaishnav, BCOM, ACA, AICWA, Executive-Accounts, Tata Exports Ltd., Shah House, 3rd Floor, Shiv
Sagar Estate, Worli, Mumbai - 400018 (Membership No. 11504) with effect from 3rd March, 2009.
6. Shri N.B. Hariharan, AICWA, No. 13, SHABARI, Survey No. 182/3, B/W. Tennis village & Telecom Colony, Off:
Thindlu Road, Vidhyaranyapura, Bangalore 560097 (Membership No. 941) with effect from 24lh November, 2006.
7. Shri Nilay Das Gupta, BCOM, ACA, AICWA, FE 245, Sec III, Salt Lake City, Kolkata 700106 (Membership No. 3425)
with effect from 13th March, 2008.
660

the management accountant, August, 2009

Institute Notification

8. Shri Sanjeev Kumar Mittal, BCOM, FICWA, House No. D- 26, Paper Mills Colony, Yamuna Nagar - 15001 (Membership
No. 17014) with effect from 13th October, 2007.
9. Shri Bal Krishan Ajmani, MCOM, AICWA, 1249, Sector - 44B, Chandigarh -160047, (Membership No. 5242) with effect
from 7th February, 2009.
10. Shri S. K. Talwar, BA, AICWA, Flat No. C-204, Rishi Apartments, Opp. Telephone Exchange, Sector- 70, S.A.S. Nagar160059, (Membership No. 3784) with effect from 7th February, 2009.
11. Ms Mondira Acharjee, BSC, FICWA, C/o. Shri A. Acharjee (Advoate), Chamber No. 502, New Lawyers Chamber
Complex, Patiala House Court, New Delhi -110001, (Membership No. 12945) with effect from 29th December, 2008,
12. Shri Prabhakar Gopal Majumdar, MA, LLB, AICWA, Plot No. 0/3, Laxmi Nagar, Nagpur - 440022, (Membership No. 9048)
with effect from 25th January, 2007.
13. Shri Anirudhar Krishan Luthra, FCA, FICWA, A-16/9, Vasant Vihar, New Delhi 110057, (Membership No. 376) with effect
from 17th March, 2009.
14. Shri Ram Jiwan Goel, BCOM, FICWA, 31, Community Centre, Golden Palace, 2nd Floor, Delhi - 110052, (Membership No.
3024) with effect from 18th April, 2009.
15. Shri K. M. Lalka, BSC, AICWA, A-I/A-II, Shital Darshan, GVS Road No. 4, Near Municipal Hospital, Mulund (West),
Mumbai - 400081, (Membership No. 4313) with effect from 7th April, 2009.
16. Shri Tarapada Chatterjee BSC, FCMA, FICWA, 32-A, Jaldarshan, Nepean Sea Road, Mumbai - 400 036, (Membership
No. 21) with effect from 24lh August, 1900.
17. Shri T.V. Satyanarayana, BCOM, FCS, FICWA, 100, Gangadeeswarar Koil Street, Purasawakkam, Chennai - 600 084,
(Membership No. 2130) with effect from 30th January, 2008.
18. Shri Pratap Narain Mehrotra, BCOM, LLB, FICWA, 116/215, Shipra Path, Agrawal Farm, Sector 11, Mansarovar, Jaipur 302 020, (Membership No. 2727) with effect from 11th April, 2009.
19. Shri S. N. Sharma, BCOM, AICWA, 90, Dhuleshwar Garden, C Scheme, Jaipur -302 001, (Membership No. 8938) with
effect from 6th October, 2008.
20. Shri C. K. Venugopalan, BSC, AICWA, Mundakkal House, Chelamattom, Okkal P.O. - 683 550, Kerala, (Membership No.
11911) with effect from 9th March, 2005.
21. Shri M. V. Ardhanari, BA, AICWA, 166, Krishnan Koil Street, Salem - 636001 (Membership No. 5692) with effect from 28th
June, 2009.
22. Shri Karuna Ganapathy, MA, BCOM, AICWA 65, Sengunthar Mettu Street, Ammapet, Salem - 636003 (Membership No.
3175) with effect from 28lh June, 2009.
23. Shri Kanhaiya Lai Lohia, BCOM, FICWA, C/o Pehchaan The Identity, House for Bedsheets, Sarees etc., Bhaskhara Plaza,
22A, Subramania Swamy Koil Street, Fair Lands, Salem - 636016 (Membership No. 2516) with effect from 28th June, 2009.
24. Shri T. R. Sankaranarayanan. BSC, AICWA, Dy. Chief Finance Manager, Salem Steel Plant, SAIL, Alagasamudram, Salem
- 636013 (Membership No. 4126) with effect from 28th June, 2009.
25. Shri R. S. Sivaraman, MA(MATH), FICWA, 16 Sannadhi Street, Subramaniya Nagar, Salem - 636005 (Membership No.
8571) with effect from 28th June, 2009.
26. Shri Noratan Mal Jopat, BCOM, ACS, A1CWA, C/o. Rita Pal, 161/1, B.M. Saha Road, Bank Park, P.O. Hindmotor - 712233,
Dist- Hooghly (WB). (Membership No. 1388) with effect from 30th June, 2009.
on account of death.
Sd/(Kunal Banerjee)
President
the management accountant, August, 2009

661

Institute Notification

Kolkata, the 2nd July, 2009


NOTIFICATION
16-CWR(8721-8731/2009 : In pursuance of Regulation 16 of the Cost and Works Accountants Regulations, 1959, it is hereby
notified that in exercise of powers conferred by sub-section (1) (b) of Section 20 of the Cost and Works Accountants Act,
1959, the Council of the Institute of Cost and Works Accountants of India has removed from the Register of Members, the
name of :
1. Shri Somen Kumar Banerjee, BCOM, ACS, ACIS, MBIM, AICWA, 13, Krishna Mallick Lane, P.O. Belgachia, Kolkata 700037, (Membership No. 1981) with effect from 1st April, 2009 at his own request.
2. Shri Kalyansri Das Gupta, BEE, PHD (MANCHESTER), FICWA, 89/S, Block E, New Alipore, Kolkata 700053, (Membership
No. 3170) with effect from 1st April, 2009 at his own request.
3. Shri Malay Kumar Ganguly, MCOM, F1CWA 29/1, Lake East, 6th Road, P.O. Santoshpur, Kolkata 700075 (Membership
No. 17660) with effect from 2nd March, 2009 at his own request.
4. Shri Sharad Wamen Athaley, BSC, FICWA, Shakuntal LB/34, V.H.B. Colony, Laxminagar, Nagpur 440022 (Membership
No. 6890) with effect from 1st April, 2009, at his own request.
5. Shri Arjun Dev Malhotra, MCOM, AICWA, KG-10, New Kavi Nagar, Ghaziabad - 201002, (Membership No. 694) with
effect from 15th March, 2009, at his own request.
6. Shri Ramchandra H. Shenoy, BCOM, LLB, F1CWA, A/6, Karnatak Buildings, Mogul Lane, P.O. Mahim , Mumbai 400016,
(Membership No. 1865) with effect from 1st April, 2009 at his own request.
7. Shri K. Sundara Raman, BSC, D1P, MA, A1CWA, 3, (Old 26), J. P. Builders Colony, Gopala Puram West, Vellore 632006, (Membership No. 4363) with effect from 22nd March, 2009, at his own request.
8. Shri S.K. Aggarwal, BCOM, FCA, ACMA, A1CWA, Vikarj, 382, Sector 15A, Noida - 201301, (Membership No. 851)
with effect from 10th March, 2009, at his own request.
9. Shri Chimalakonda Amareswara Sarma, BSC, MA(ECON), MCOM, AICWA, H. No. 1-10-122/19, 2nd Floor, Ashok
Nagar, Hyderabad - 500020, (Membership No. 25034) with effect from 27th April, 2009 at his own request.
10. Dr. Mam Chandra, MA, MCOM, PHD, FICWA, Reader in Commerce, R.H. Govt. P.G. College, U.S. Nagar, Kashipur - 244
713, (Membership No. 15767) with effect from 13th Octobcr, 2008 at his own request.
11. Shri K. N. Parthasaaraty, MCOM, FICWA, Turabi Archies Enclave, G-4, 16-11-317, Moosarambagh, Malakpet, Hyderabad
- 500036 (Membership No. 787) with effect from 30th June, 2009 at his own request.
Sd/(Kunal Banerjee)
President
Contd. from Page 659
transactions are acceptable to traders
and financiers as well. The main reason
to bring UCP 500 was more in line with
modern day practices that recognize the
changing patterns of trade.
Globalization has had a tremendous
impact not only on the opening up of
the economies, but also on the
consequential relationships and
business practices between traders
across the globe. Internet has created
revolution and international trade and
commerce is now at no distance.
Though UCP 600 has provided
solutions to various problems but still
there is lot of scope for improvement.
662

There are some grey areas viz. Article 1


states that these are rules and binding
on all parties unless expressly modified
or excluded by the credit. If issuing bank
has option to modify or exclude any
rule, then where is uniformity? Likewise
UCP 600 is silent about the situation
when the original credit is lost, stolen,
mutilated or destroyed. The words
"satisfied itself as to apparent
authenticity" in Article 9 leave a scope
for subjectivity interpretation which
may lead to difference of opinion in case
of dispute. Similarly, the words,
"whether or not the documents appear
on their face to constitute a complying

presentation", may lead to subjective


judgment. Even though there some grey
areas but UCP 600 has solved many
problems relating to letters of credit and
is "the most comprehensive in the entire
history of the rules." Before
introduction of UCP 600, it was found
that more than 50% of the documents
presented by the importers and
exporters to the banks for payment
under the letters of credit were rejected
on their first presentation. It is estimated
that more than 70% of documents
presented are now being readily
accepted on their first presentation.q

the management accountant, August, 2009

the management accountant, August, 2009

663

Book Scan

Law of Contract & Specific


Relief
By Dr. Avtar Singh,
By Eastern Book Company
(P) Ltd.,
Lucknow-5th Edition,
Price Rs 250.00

r. Avtar Singh's text book on Law


of Contract & Specific Relief was
first published in 1978. The
revised and enlarged 5th edition of this
treatise in law, divided in 12 chapters
carries forward this dynamic process
towards the new emerging law horizons.
It is an enjoyable transition from basic
key concepts to most contemporary
developments not only for students and
practitioners but also to professionals
like company secretaries, accountants
and alike.

revised the contents of the present


edition. The subject-index by the
addition of newer headings and subheadings will hopefully be admired by
the readers. As an author of text book,
Dr. Singh has rightly covered the
chapters on quasi contracts, contracts
of indemnity, guarantee, bailment,
pledge and reference is also made as
per statutes.

While basic objective is to provide


knowledge of the concepts,
applications and practices in Law of
Contract and Specific Relief, it also
meets the needs of practitioners. The
lucid exposition and simple narrative
ensures that the reader can quickly
grasp and absorb the subject. The
author discusses at length many new
developing areas and various intricate
aspects of the subjects under study.
Both the practical and academic
importance and interest are cited which
reflect the socio economic changes.

The book is divided in 12 chapters in a


logical manner. Chapter I deals with
agreement, contract, proposal and
acceptance. Starting with the definition
of contract, it ends with the revocation
of acceptance. Chapter II discusses
consideration. Here, exceptions to the
"privity rule" have been narrated in a
very lucid manner. Chapter III explores
the capacity to contract and here, the
effect of minor's agreement, have been
discussed in a nice way. With the
declaration of the privy council in the
famous case of Mohoribibee vs
Dharmodas Ghose, and few other cases,
the author has discussed at length ,on
the effects of minor's agreement.
Chapter IV provides free consent.
Coercion, misrepresentation, undue
influence, fraud, mistake - all the aspects
have been discussed in depth, in this
chapter. All the chapters have
subdivisions. Chapter V deals with
legality of object, the chapter is divided
into two subsections; unlawful objects
and void agreements. Here in this
chapter, the exceptions with respect to
horse race and crossword competitions
have been discussed nicely. Chapter VI
provides discharge of contract. This
chapter is again subdivided. Here,
appropriation of payments and
measures of damages for breach has
been discussed in a lucid manner.

Dr. Avtar Singh has written in a clear


and simple manner and being a
distinguished author, he has thoroughly

Chapter VII deals with contract of


indemnity. Chapter VIII discusses
Guarantee, its economic functions,

The previous editions of the author, on


the particular subject, got an
enthusiastic reception from readers and
reviewers but to make the subject more
comprehensive and amended, this
edition thoroughly overhauls last
edition. Much has been added to deal
with the important developments on the
subject.

664

extent of surety's liability and discharge


of surety from liability by revocation,
by death, by variance and the
practicalities of it. Chapter IX discusses
bailment, rights and duties of bailee and
the factors of general and particular lien
has been discussed in such a simple
manner that students can understand it
easily.ChapterX deals with pledge.
Chapter XI deals with agency and right
of agent along with the relations of
principal with third parties have been
discussed nicely. Chapter XII deals with
Specific Relief Act. The Specific Relief
Act of 1963, which replaced the earlier
act of 1877, provides the remedial
measures for forcing parties to perform
their actual contractual commitments
and not to get rid of them by just paying
compensation for their Acts. In the
preface, the author has proved that the
book has been written with an effort to
meet the requirements of the students.
A glimpse of this book is sufficient to
bring home that it is a comprehensive
text book on the mentioned subject.
Each chapter of the book is logically
arranged. At the end of each chapter
theoretical questions are given to test
the overall knowledge of the students
from the concerned chapter. The book
is highly recommended for students of
law, management and for students
appearing in professional examinations
such as, ICWA., C.A., CS. The book will,
no doubt, meet the demands of the
readers on the subject.
The book is reasonably priced. The get
up & quality of printing is good and
hope this book will get justice
throughout the country. Unique in its
scope and written with the aim of
meeting the needs of the students as
well as the professionals, this edition
will appeal to all concerned with the laws
on contract.
Dr. Sumita Chakraborty,
Director (Studies), ICWAI

the management accountant, August, 2009

Book Scan

Efficiency Management
By Tarkeshwar Pd. Maitin
By New Central Book Agency
(P) Ltd.,
Rs 195.00

fficiency is an intellectual asset


and is a guiding force in career
development. In the backdrop of
globalization, the word 'efficiency' has
become a buzzword which has led to
the development of new management
dimensions and approaches. A fresh
approach to the interrelationship
between management and efficiency will
ensure social prosperity and economic
development as well.
This particular book of the author, which
is the first edition, argues for a process
based approach to the study of
efficiency management. The aim of the
book is to examine, whether by studying
efficiency management, one can operate
efficiently. The book is well written and
is more geared towards increasing
efficiency in business. Mainly the
significance of efficiency in some areas
of operation, analyzing the problems
associated in the process (of operation)
and establishes the need for an
organized attention to this special
aspect of management.
The book is divided into 17 chapters.
The book commences from identifying
the areas of efficiency in the
organization. So, in chapter 1 ,starting
from the concept of efficiency, the
author has discussed the associated
problems and the systems of
management, which may help to
enhance the quality of talent as well as
social quality by increasing efficiency
of human beings.
In the second chapter, how management
as an interdisciplinary as well as
interdependent approach translates
human efforts into dynamic
contributions for the purpose of
organizational growth, have been
discussed.

Chapter3 deals with policy, which is a


significant link between planning and
execution. Policy, as a base to efficiency
of operations in management, is one of
the foundations of efficiency
management; the author has made a
good attempt to show that
In chapter 4, nature and characteristics
of decisions, which is a substantial
indicator of efficiency and integrity, has
been discussed.
Efficiency is a basic entrepreneurial
challenge and also a common goal of
action. The entire success or failure of
an organizational performance is largely
governed by the level of efficiency
established by the management, is the
basic analysis of chapter5.
Chapters 6 & 7 discusses how the
reliable marketing information system
can be a motivational factor as also how
incentive can be an essential
motivation to efficiency. Mainly, the
relevance and reliability of skills, which
with effective marketing, can govern the
possibilities of a favorable decision.
Incentive depends on the performance
of any person. To identify the need for
performance efficiency, examining the
factors governing the formulation of an
effective wage policy is the basic aim in
chapters 8 & 9. Efficiency is
instrumental in bringing down the
labour cost per unit of output which
means in terms of efforts and energy.
Value addition to personal growth is an
essential component of efficiency.
Identification of talent, recognizing that
talent and to improve the contents &
relevance of such talent- are the basic
discussions in the chapters 10 & 11.
Major goal of financial management is
the maximization in the value of a firm
and that is closely related to the
efficiency of its operations. The
efficiency of financial management
largely governs the development of an
organization. The areas of efficiency
may be wider but the net achievement
is common. Only an organized effort can

the management accountant, August, 2009

ask for development. An efficient


management is governed by a
disciplined attitude and integrated
approach.
Chapters 12, 13 & 14 deals with the ideas
of control & accounting. Control, which
is the basic instrument of managerial
efficiency, is a comprehensive and
systematic approach and the entire
management operation needs a careful
and suitable technique of assessment
and appraisal. In terms of interpretation
of analysis accounting plays a
significant role in management
development .The author has rightly
pointed out the need for accounting and
control, in discussing with the
efficiency management.
In chapter 17, the concluding comments
about the effects of the context in which
efficiency management has been
introduced, well been discussed in the
book.
A great diversity of experience and
many positive outcomes are reported
for case studies. The attempts to
evaluate case studies and interpret the
findings and a text broken by box
inserts, exercises at the end of the
chapters, glossary and appendices has
made the book worthy reading. What
the book does do and it does very well,
is to provide an intellectual pedigree
and analytical rationale for viewing the
employment relationship in more
interesting and dynamic ways than the
traditional industrial relations
perspective of how rules are made and
modified.
Overall, I believe, the book will be useful
for students carrying out professional
courses like CWA, CS, CA and courses
of the like, which will help them in
building their intellectual ability. The
book is reasonably priced. The get up
& quality of printing is good and I also
believe that the organizations for
financial services should certainly take
note of its contents.
Dr Sumita Chakraborty
Director (Studies), ICWAI
665

Notice

DEPARTMENT OF PUBLIC ENTERPRISES


GOVERNMENT OF INDIA
and
THE INSTITUTE OF COST AND WORKS
ACCOUNTANTS OF INDIA
Jointly Organising
Intensive Programme on
CORPORATE TAX - PLANNING,
COMPLIANCE & MANAGEMENT
29-31 JULY, 2009
at
NEW DELHI
COURSE COVERAGE
Accounting Laws Vs. Tax Laws
Provisions of Minimum Alternate Tax, Planning & Management thereof
Tax Management
Planning for Expenditure and Impact on FBT & TDS
International Taxation -Transfer Pricing Mechanism, Double Taxation Avoidance Agreement and Provisions of TDS on

Foreign Remittances
Provisions relating to Exemptions/ Deductions under the Income Tax Act
Managerial Decisions and Tax Impact thereon
Issues in Corporate Taxation
ABOUT THE INSTITUTE
The Institute of Cost & Works Accountants of India was established by the Government of India as an autonomous
professional Institute in 1959 to provide training, education and research facilities in cost and management accounting. The
Institute is a member of the International Federation of Accountants (IFAC), the Confederation of Asian & Pacific Accountants
(CAPA) and the South Asian Federation of Accountants (SAFA).
THE OBJECTIVE
To promote the knowledge of Cost and Management accountancy, to provide educational facilities for training of young

men and women for building careers in management accounting.


To improve the decision making skills and administrative competence relevant to management accounting and corporate

management in general.
To create knowledge through research both applied and conceptual relevant to management on cost accounting and its

undenying disciplines so as to disseminate such knowledge through publications.

666

the management accountant, August, 2009

Notice

THE TRAINING PROGRAMMES


The Institutes efforts are directed towards quality training and introducing new programmes to meet emerging challenges of
the corporate world.
Broadly the programs are classified as :
u

Training programs for practicing managers of both public and private sectors, Banks, Financial Institutions, Insurance
Companies, Multinationals and Government Departments.

Programmes for its own professional members, and

Tailor-made in house training programs for Industry, Govt Departments and Public Services. It also offers specific
programs for Defence, Railways, Telecom and Public Utility Services.
President
SHRI KUNAL BANERJEE
Vice President
SHRI A. S. DURGA PRASAD
Chairman, Continuing Education Programme Committee
Dr. SANJIBAN BANDYOPADHYAYA

PROGRAMME ON
CORPORATE TAX - PLANNING,
COMPLIANCE & MANAGEMENT
Dear Sir/ Madam,
We are happy to inform you that we are organizing a programme on Corporate Tax - Planning, Compliance and
Management during 29-31 July, 2009 at New Delhi.
We request you to kindly participate/ depute your executives for this programme which will be of immense use and benefit
to your executives and organization on this subject.
With regards,
Dr. Sanjiban Bandyopadhyaya
Chairman,
CEP Committee, ICWAI
FOR WHOM
Senior and Middle level Executives from Public and Private Sector Enterprises, Banks, Financial Institutions, Insurance
Companies, Multinational Companies and Government Departments will find the programme rewarding.
METHODOLOGY
The programme will be developed through lectures, discussions and case studies using audio-visual equipments.
FACULTY
Eminent experts and professionals in the field of Corporate Taxation will be dealing with the subjects.
COURSE DIRECTOR
Prof. S. Sampath, M.com, FCA, LL.B, MBA, M.Phil., M.A. (Ecology) Corporate Tax and Management Consultant, New Delhi
VENUE
Hotel The Park
15 Parliament Street, Connaught Place
New Delhi - 110 001
Phone : 011-23743000 Fax : 011-23744000
DATES
29-31 July, 2009 (10.00 - 17.00 Hrs.)
the management accountant, August, 2009

667

Notice

PARTICIPATION FEE
The programme is Non-Residential.
Rs. 12,000/- (Rupees Twelve thousand only) per participant. Fee includes course fee, course material, lunch, tea /coffee
during the programme.
The Cheque/ DD to be drawn in favour of The Institute of Cost and Works Accountants of India payable at New Delhi.
Details for ECS Payment : State Bank of India, Lodhi Road Branch, New Delhi - 110 003 Current A/c No. : 30678404793
MICR Code : 110002493 IFSC Code : SBIN0060321
For Kind Information : For outstation programmes the participants are requested to get the confirmation from the Institute
before proceeding to the venue. The Institute will not be held responsible if any participant reaches the venue for the
postponed/ cancelled programme without getting the confirmation from the Institute. The cancellation/ postponement of
the programme, if any, will be intimated to only those organizations whose nominations have been received by the
Institute on time.
REGISTRATION
For further details and Registration please contact:
Shri D. Chandru, Addl. Director (PD&P)
The Institute of Cost and Works Accountants of India
Professional Development and Programme Directorate
ICWAI Bhawan, 3 Institutional Area,
Lodi Road, New Delhi - 110 003
Phones : 011-24622156, 24618645 (D) 24643273 (M) 9818601200
Tele-Fax: 011-43583642 / 24622156 / 24618645
E-Mail : mdp@icwai.org, cep.chandru@icwai.org
Website: www.icwai.org

Intensive Seminar
on

INTERNATIONAL
FINANCIAL REPORTING STANDARDS (IFRS)
by

Dr. T. P. Ghosh
New Delhi
Chennai
Kolkata
Mumbai

at
: 21-22 May, 2009
: 18-19 June, 2009
: 23-24, July, 2009
: 6-7, August, 2009

ICWAI
THE INSTITUTE OF COST & WORKS ACCOUNTANTS OF INDIA
(Set up under an Act of Parliament)
668

the management accountant, August, 2009

Notice

COURSE DIRECTOR
Dr. T. P. Ghosh
M. com., Ph. d., FCA, FICWA
Dr. T. P. Ghosh is prolific writer in the area of accounting and finance. His book Accounting Standards and Corporate
Accounting Practices is an authentic commentary on the national and international financial reporting standards. His recent
book Understanding IFRSs has been released in February, 2009. He wrote extensively in the Gulf News on contemporary
financial issues in the GCC and on contemporary accounting issues in the Corporate Professionals Today published
byTaxmann , New Delhi.
Dr. Ghosh was formerly Director of Studies in the Institute of Chartered Accountants of India ( 2004-06). He was a member of
the J. J. Irani Committee (2005-06) constituted for the Simplification of the Company law. Presently , he is a Professor at the
Institute of Management Technology, Dubai.
ABOUT THE INSTITUTE
The Institute of Cost & Works Accountants of India was established by the Government of India as an autonomous
professional Institute in 1959 to provide training, education and research facilities in cost and management accounting. The
Institute is a member of the International Federation of Accountants (IFAC), the Confederation of Asian & Pacific Accountants
(CAPA) and the South Asian Federation of Accountants (SAFA).
THE TRAINING PROGRAMMES
v The Institutes efforts are directed towards quality training and introducing new programmes to meet emerging challenges
of the corporate world.
Broadly the programs are classified as :
v Training programs for practicing managers of both public and private sectors, Banks, Financial Institutions,
Insurance Companies, Multinationals and Government Departments.
v Programmes for its own professional members, and
v Tailor-made in house training programs for Industry, Govt. Departments and Public Services. It also offers specific
programs for Defence, Railways, Telecom and Public Utility Services.
President
Shri Kunal Banerjee
Vice President
Shri A. S. Durga Prasad
Chairman, Continuing Education Programme Committee
Dr. Sanjiban Bandyopadhyaya

INTERNATIONAL
FINANCIAL REPORTING STANDARDS (IFRS)
COURAGE COVERAGE
v Accounting for property, plant and equipment; intangible assets; decommissioning; restoration and similar liabilities;

web site costs.


v Accounting for financial instruments : recognition, measurement, presentation and disclosures, embedded derivatives,

held to maturity accounting - crisis of fair value accounting.


v Share based payments
v Non-current assets held for sale and discontinued operations
v Employee benefits
v Issues in Revenue Recognition : Construction Contracts, service concession arrangement, barter transaction involving

advertising services
v Issues in consolidation : Special Purpose Entities
v Operating Leases
v Investment Property

the management accountant, August, 2009

669

Notice
v Agriculture
v Foreign Currency Transaction
v First Time Application of IFRS

METHODOLOGY
The seminar will be developed through lectures, discussions case studies using audio-visual equipments.
FOR WHOM
Senior and Middle Level Executives of Public and Private Sector Undertakings, Multinationals, Autonomous Bodies, Insurance
Companies, Financial Institutions and Government Departments will find the Seminar rewarding.
VENUE
New Delhi

: Hotel The Park, Connaught Place, New Delhi

Chennai

: Hotel Savera, Dr. Radhakrishnan Salai, Channai- 600004

Kolkata

: Hotel Pearless Inn, J. N. Road, Kolkata

Mumbai

: The Ambassador Hotel, Mumbai

PARTICIPATION FEE
New Delhi, Chennai and Kolkata - Rs. 8000/- per participant
Mumbai : Rs. 10,000/- per participant
The Programme is non-residential.
The Cheque/DD to be drawn in favour of the Institute of Cost and Works Accountants of India, payable at New Delhi
Details for Ecs Payment : State Bank of India, Lodhi Road Branch, New Delhi -110 003
Current A/c No.: 30678404793 MICR Code : 110002493 IFSCCode:SBIN0060321.
FOR KIND INFORMATION
For outstation programmes the participants are requested to get the confirmation from the Institute before proceeding to the
venue. The Institute will not be held responsible if any participant reaches the veneue for the postponed/cancelled programme
without getting the confirmation from the Institute. The cancellation/postponement of the programme, if any, will be intimated
to only those organizations whose nominations have been received by the Institute on time.
REGISTRATION
For further details and Registration please contact :
Sh. D, Chandru Addl. Director (PD&P)
The Institute of Cost and Works Accountants of India
Professional Development and Programme Directorate
ICWAI Bhawan, 3 Institutional Area,
Lodi Road, New Delhi - 110 003
Phones : 011-24622156, 24618645
(D) 24643273 (M) 9818601200
Tele-Fax : 011-43583642 / 24622156 / 24618645
E-mail : mdp@icwai.org Website : www.icwai.org

670

the management accountant, August, 2009

Notice

COURSE COVERAGE

the management accountant, August, 2009

671

Notice

PROGRAMME SCHEDULE
u
u

u
u

u
u

u
u

u
u

u
u

672

the management accountant, August, 2009

Notice

FOR WHOM

PARTICIPATION FEE

v
v
v
v
v

29th August 2009


REGISTRATION

the management accountant, August, 2009

673

Notice

LIST OF ORGANISATIONS BENEFITED FROM THE EARLIER


INTERNATIONAL PROGRAMMES OF THE INSTITUTE

ABOUT THE INSTITUTE

THE TRAINING PROGRAMMES

President
Vice President
Chairman, Continuing Education Programme Committee

674

the management accountant, August, 2009