Anda di halaman 1dari 80

PRESIDENT

Kunal Banerjee
email : president@icwai.org
VICE PRESIDENT
A. S. Durga Prasad
email : vicepresident@icwai.org
CENTRAL COUNCIL MEMBERS
Chandra Wadhwa, V. C. Kothari,
A. N. Raman, S. R. Bhargave,
Somnath Mukherjee, G. N. Venkataraman,
Hari Krishan Goel, Dr. Sanjiban
Bandyopadhyaya, M. Gopalakrishnan,
Suresh Chandra Mohanty, Ashwin
G. Dalwadi, Balwinder Singh,
B. M. Sharma
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.
Joint Director (CEP)
D. Chandru
cep.chandru@icwai.org.
Joint Director (Membership)
Kaushik Banerjee
membership.kb@icwai.org.
Joint 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. 2 February 2009


Editorial

91

Issues & Concerns

Presidents Communique

92

Behavioral Finance A Discussion on


Individual Investors Biases

Cover Features
Measurement and Management of
Risk

by Dr. M. Bhatt H.S.

by Dr. V. Gangadhar &

Intellectual Property and its


Pervasiveness in Industry, Trade and
Commerce

Dr. G. Naresh Reddy

94

Risk Reporting : An Essence of Risk


Management
by Subhajit Ghosh

99

Operational Risk : An Important Issue


in Modern Banking
by Soumya Mukherjee

107

142

Golden Jubilee Commemorative


Address

128

Legal Updates

144

E-mail Ids

164

Regional Conference at Chandigarh168


IDEALS
THE INSTITUTE STANDS FOR

IAS 17 : Leases - A Closer Look


115

Outsourcing
Outsourcing - an opportunity
by P. Subramanian

by Avik Ranjan Roy

112

Accounting Issues
by K. S. Muthupandian

Finance & Accountancy

Enterprise Risk Management (ERM)


by Adithya Bhat

138

121

q to develop the Cost and Management


Accountancy profession q to develop
the body of members and properly
equip them for functions q to ensure
sound professional ethics q to keep
abreast of new developments.

Emerging Issues
Employee Governance
by R. Soundara Rajan &
Chitra Rajan

123

Finance
Non-Performing Assets
Management of Non-banking
Financial Companies : An
Introspection
by Jafor Ali Akhan

the management accountant, February, 2009

132

The views expressed by contributors or


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.

89

The Management Accountant


Technical Data
Periodicity
Language

MISSION STATEMENT

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.

Monthly
English

Overall size - 26.5 cm. x 19.5 cm.


Printed Area - 24 cm. x 17 cm.
Screens - up to 130
Subscription
Rs. 300/- (Inland) p.a.
Single Copy : Rs. 30/Overseas

VISION STATEMENT

US $ 150 for Airmail


US $ 100 for Surface Mail
Concessional Subscription Rates for Registered Students
& Grad CWAs of the Institute

Rs. 150/- p.a.


Single Copy : Rs. 15/- (for ICWAI
Students & Grad CWAs)
Subscription rate and price of
The Management Accountant
(Student Edition)
Annual Subscription rate
: Rs. 50
Price of Single copy
: Rs. 5
Advertisement Rates for
The Management Accountant
Back Cover (colour only)

Rs. (US $)
30,000 2,000

Inside Cover (colour only)

25,000

1,500

Ordy. Full page (B/W only)

12,000

1,200

Ordy. Half page (B/W only)

9,000

1,000

Ordy. Qrtr. page (B/W only)

5,000

500

ICWAI would be the preferred source of


resources and professionals for the financial
leadership of enterprises globally.

DISCLAIMER
The views expressed by the authors
are personal and do not necessarily
represent the views and should not
be attributed to ICWAI.
FOR ATTENTION OF MEMBERS

Advertisement Rates for


Student Edition
Full Page

Rs.

10,000

Back Page

Rs.

8,000

Inside Half Page

Rs.

5,000

Inside Quarter Page

Rs.

3,000

(Always Half Page only)

The Institute reserves the right to refuse any


matter of advertisement detrimental to the
interest of the Institute. The decision of the
Editor in this regard will be final.
the management accountant, February, 2009

CD of List of Members, 2008 will be made


available for sale to the Members at a price
of Rs. 100/- per copy. Members interested
to procure the same may remit Rs. 100/- by
Demand Draft drawn in favour of ICWA of
India, payable at Kolkata, addressed to the
Secretary, ICWAI.
90

Editorial
Its a risky business
Readers will observe that ever since the financial
tsunami erupted, we have been carrying in each edition
of the journal, issues on which this global crisis has a
bearing - the likely impact of the financial upheaval on
the outsourcing sector (September issue); the effect
the slump will have on the globes efforts to tackle
climate change (October issue); the emergence of the
Micro Finance Institutions (MFIs) as an alternative
source to provide affordable credit with the drying up
of formal credit channels (November issue); the raging
debates over new accountancy norms (December
issue) and the increasing need towards Human Resource
Accounting (January issue). Inclusion of such articles
on different sectors of the economy that have current
relevance has been widely received and appreciated by
our readers. This has encouraged us to continue with
the practice of highlighting another area badly hit by
the financial crisis.
In this issue we focus on risk management. Risk
Management is an elite word in financial literature yet
much maligned against the backdrop of frequent crises.
Risk in financial parlance means the possibility of lower
earnings or downright loss. We are also aware that no
risk, no return. Hence, risk is an inseparable way of
doing business. Financial risk can either be ignored (if
it is small vis--vis return) or it can be avoided (by not
undertaking that business venture at all) or removed
and in the most likely case the impact mitigated. Risk
management would thus imply putting mechanisms and
measures in place to accept/ limit/ transfer this risk
that can emerge from any source- business operations,
fluctuations in market variables, possibility of default
in funds lent/ invested, external events etc. Risk
management architecture encompasses risk
identification, risk measurement (through sensitivity,
simulation models), risk monitoring (through VaR
models), risk mitigation (e.g. derivatives) and Board
oversight in the form of policy formulation, execution
and independent audit.
The characterizing feature of the financial world in recent
times has been the quantum jump in innovations relating
to risk management. Greater financial integration
among countries, more intense competition between
the financial players, development in the field of IT
which enabled the emergence of sophisticated risk
the management accountant, February, 2009

modeling techniques to measure and monitor risks,


greater regulation which spawned the need to
circumvent the stringent rules- all these have played a
role in the development and refinement of risk
management.
Many would blame the sub prime crisis to risk
management as they feel conventional business got lost
in the esoteric world of risk management. Yet it must
be remembered that the crisis occurred due to the lack
of prudent risk management practices rather than
because of its existence. Evidently, risk management
practices were flouted/ ignored at every level of the
sub prime crisis. The lenders of the housing loans
acquired substantial credit risk both at the origination
(loans sanctioned without proper due diligence) and
post disbursal stages (by securitisation). Investment
banks in a bid to be ahead in the competition had over
leveraged themselves and thus exposed themselves to
risk arising from insufficient capital. Entities, both
financial and non financial were subjected to market
risk on account of huge exposures to complex derivative
products. Further, internal risk management practices
like watertight segregation of risk origination and risk
audit were not followed leading to operational risk. All
these underscore the need for risk management instead
of vilifying it.
Risk management, as a concept is not new, even to
Indian business. When a banker appraises a prospective
borrower before sanctioning a loan, he is in effect
guarding against credit risk. When a farmer enters into
a contract with the local mandi today to sell his crop
three months later at a price determined today, the
farmer is basically protecting himself from possible
market risk. The risk management literature in its
present avatar is essentially a systematic approach to
curtail ones losses and stabilize ones profits. The Basel
Accord is an example of a comprehensive risk
management policy document for adoption by the
banking world.
It is hoped that the articles on the cover feature will aid
in the understanding and familiarity with risk
management concepts. This will equip our Cost
Accountants towards further progress and development
in this area.
91

l Presidents Communique l
My dear Professional Colleagues,
We are living in turbulent times. Even before recovering from the global financial crisis,
we are confronted with more challenges, which are equally damaging albeit on a more
local scale. The Madoff scandal in US and back home in India the Satyam episode are
two such events, which have succeeded in denting the already sagging confidence
among the business community. Both are examples of greed and failure and inadequacy
of corporate governance and underscore the indispensability of ethics, proper regulation,
independent audit and above all effective checks and balancing with business
performance in a public organisation. The current situation arising out of serious lapses
in Corporate Governance in India drives home the point which we have been advocating
regarding Enterprise Governance. Corporate governance is about how companies are
directed and controlled. It is focused on conformance with regulations. This conformance
is of course necessary but a governance structure should also support an organizations
efforts to improve performance. It has to come out of a check-list mentality which leads to governance in name and not
in spirit. There is an urgent need to move from compliance governance to business governance which also happens to
be the considered view of the International Federation of Accountants (IFAC) (Report on Financial Reporting Supply
Chain).
In our view, this governance structure has to expand its horizon to include a system that ensures optimal utilisation of
resources for the benefit of shareholders while meeting societal expectations. There has to be a shift from compliance
or rule based governance to a performance management framework with enterprise governance in mind. To
achieve this IFAC has recommended suitable performance management systems for the functioning of the audit
committee. The Expert Group constituted to review the mechanism of cost accounting records and cost audit has also
recommended this shift of the framework of cost audit from being compliance or rule based governance to a performance
management framework with enterprise governance in mind. These recommendations acquire great significance in the
current context of governance failure. The Ministry should get the report examined at the earliest so that the issues of
enterprise governance and corporate competitiveness are addressed, to avoid repetition of another corporate financial
catastrophe.
SEBI has desired a second audit of all the listed companies. We feel that such an audit should be conducted by a firm
of Cost Accountants who have greater capabilities to focus on input-output structures in an enterprise and find
justification and correctness of the declared profits. Such an opinion is also echoed in the IFAC survey on the
Financial Reporting Supply Chain. Many developed countries have Accounting Oversight Boards to regulate the
statutory services of accounting professionals. An independent Regulatory body may be considered in India to
regulate the services of statutory auditors of companies.
The month of January was very eventful for the Institute. January 15, 2009 was a red letter day for our Institute when
Bharat Ratna Dr. A.P.J. Abdul Kalam addressed the members at Pune and delivered the Golden Jubilee Commemorative
Address marking the 50th year of enactment of the Cost and Works Accountants Act. The key message of Dr. Kalam
to the professionals was Promote Profit with Integrity Work with integrity and Succeed with integrity. You can
also find the speech in the web sites of Dr. Kalam as well as of the Institute.
Formal announcement of the Certificate Course in Accounting Technicians was held at New Delhi on January 9, 2009.
The details of the Memorandum of Understanding between our Institute and the Chartered Institute of Management
Accountants, UK were also announced at the same function. I am happy to inform you that a final passed ICWAI
candidate will be able to take direct admission for the Strategic Level Examination of CIMA after passing CIMA
Professional Gateway Examination (CPGA). The MoU with CIMA, UK heralds an era of opening up of globalization for
the Indian students and an opportunity to attain International accounting qualification at a fast pace. Ms. Tam Kam
Peng. Head of Alliances & Learning Partnerships, CIMA attended the function. The modalities regarding the CPGA
are appearing in our website. Members interested in getting the CIMA qualification can refer to the site of the Institute
for further details.
92

the management accountant, February, 2009

l Presidents Communique l
The National Institute of Securities Markets (Established by Securities and Exchange Board of India) organized
executive education programme in Mumbai for training of auditors of broking firms. Shri A. S. Durga Prasad, Vice
President attended the programme and addressed the Inaugural function on January 9, 2009. Shri Durga Prasad also
had discussions with SEBI officials regarding scope and areas where cost and management accountants can extend
their services to SEBI to enable SEBI to perform their regulatory functions in a more effective manner.
As a part of the ongoing Silver Jubilee Celebrations of SAFA, our Institute organized a Seminar on Target Costing at
New Delhi on January 17, 2009 along with CII-TCM Division and Automotive Components Manufacturers Association
as Technical Partners. Shri Jitesh Khosla, Joint Secretary, MCA inaugurated the Seminar which was very well attended.
The Institute is also planning to hold chain seminars on Enterprise Governance in collaboration with CIMA, UK,
seminars on Audit of Stock Brokers as mandated by SEBI as well as seminars in all the four regions on Ethics and
Practices for Professional Accountants, which is the need of the hour.
The Northern India Regional Council and Chandigarh Chapter organized the NIRC Regional Cost Convention at
Chandigarh during January 3-4, 2009. I take this opportunity of congratulating the organizers for a very successful
convention, which was inaugurated by Shri Randeep Singh Surjewala, Minister for Power & PWD, Govt. of Haryana.
Shri P. K. Bansal, Union Minister of State for Finance, Govt. of India presided over the function.
The Golden Jubilee National Convention was organised by the Western India Regional Council and Pune Chapter of
Cost Accountants at Pune during January 29-31, 2009. The Convention was preceded by a Students Convention,
Practitioners Meet and Lady Cost Accountants Meet on January 28, 2009. The technical sessions of the Convention
were very lively with intense participation of the delegates and participants. The Plenary Session was followed by a
meet of Industrialists discussing the role of cost and management accountants in making India Inc. globally competitive.
I congratulate the WIRC and Pune Chapter for a very successful organisation of the Convention, which was attended
by a large number of delegates across the country, all the regional councils and representatives of Chapters from
across the country.
The SAFA Assembly was held at Pokhara, Nepal on January 25-26, 2009, which elected Mr. Sheikh A Hafiz of ICA
Bangladesh as President and Mr. Komal Chitracar of ICA Nepal as Vice President of SAFA for the year 2009.
As part of the continuing knowledge initiatives, ICWAI organised a highly informative two-day session on International
Financial Reporting Standards (IFRS), the most important development towards convergence of global accounting
standards. Dr T.P.Ghosh, an expert in this field delivered the lectures on January 12 and 13, 2009. The programme was
attended by a wide cross section of practicing accountants, professionals, coprorates and students alike.
I am glad to inform you that we have released the final cost accounting standard on materials. Other Exposure drafts
have also been released and are available on the Institutes website. I request all our members to send their observations
and suggestions on the exposure drafts to the Technical Directorate to make the standards more meaningful and
comprehensive.
We have also released Management Accounting Guidelines on Internal Audit and Guidelines on Valuation for Captive
Consumption for the help and benefit of the members and the industry at large.
In this months journal we focus on the vast and dynamic area of risk management. Our members are likely to benefit
from the articles on risk management as a driver of growth.
With warm regards
Yours sincerely,

Kunal Banerjee
President
the management accountant, February, 2009

93

Cover Feature

Measurement and
Management of Risk
Risk is all-pervasive. The philosophy of treating risk has gained wide popularity
because it is not just a threat but also a powerful device to combat fierce
competition and ultimately to learn how to grow and survive amid all adversities.
There should be always a trade-off between return and risk. In the present era of
globalization and changing global environment risk measurement and
management is also one of the important functions of the financial manager. The
risk will influence in a greater way for its all future operations. Therefore, we
made an attempt to analyze different types of risk, methods for risk measurement
and the steps involved in the management of risk of a business firm.

Dr. V. Gangadhar*
Dr. G. Naresh Reddy**
Introduction

isk Management encompasses


a wide variety of different types
of risk in any corporate
enterprise - market, credit, liquidity,
event and operational. Five key forces
are changing the way that senior
managers in major companies round the
world view their future - new
technologies, globalization, non - bank
competition, deregulation and the
opening up of previously protected
markets. 1 The true measure of a
businesss success is the rate at which
it can improve its range of products/
services and the way it produces and
delivers them. Risk measurement and
management is also one of the important
functions of the financial manager. In
the changing global environment his
decisions are affected by risk in a
perceptible way. Therefore, we made an
attempt to examine the different types
*Convener, ICET-2006 and Professor of
Commerce and Business Management,
Kakatiya University, Warangal -506009.
**Lecturer, Department of Commerce and
Business Management, University Arts &
Science College, Kakatiya University,
Warangal -506 001.

94

of risk, its measurement and


management in a business business firm.
Meaning
Risk : There are many definitions
of risk; they depend on the specific
application and situational contexts. In
general, every risk (indicator) is
proportional to the expected losses
which can be caused by a risky event
and to the probability of this event.
James C. Van Home has defined the risk
as the variability in the expected
earnings of a company. Therefore, the
differentiation of risk definitions
depends on the losses context, their
assessment and measurement, as well
as, when the losses are clear and
invariable, for example a human life, the
risk assessment is focused on the
probability of the event, event
frequency and its circumstances. We try
to define the term risk in the point of
view of engineers, financial managers
and statisticians.

Financial definition of Risk: The


chance that an investments actual
return will be different than expected.
This includes the possibility of losing
some or all of the original investment. It
is usually measured by calculating the
standard deviation of the historical
returns or average returns of a specific
investment. Risk in finance, as defined
by Ron Dembo, is quite general methods
to assess risk as an expected after-thefact level of regret. Such methods have
been successful in limiting interest rate
risk in financial markets. Financial
markets are considered to be a proving
ground for general methods of risk
assessment. A fundamental idea in
finance is the relationship between risk
and return. The greater the amount of
risk that an investor is willing to take
on, the greater the potential return. The
reason for this is that investors need to
be compensated for taking an additional
risk.
Statistical definition of Risk: It is
mapped to the probability of some event
which is seen as undesirable. Usually
the probability of that event and some
assessment of its expected harm must
be combined into a believable scenario
(an outcome) which combines the set
of risk, regret and reward probabilities
into an expected value for that outcome.
Thus, in statistical decision theory, the
risk function of an estimator 6 (x) for a
parameter 6, calculated from some
observables x; is defined as the
expectation value of the loss function
L,
R(, (x)) = L (, (x)) (x/) dx
Where : (x) = Estimator; = the
Parameter of the Estimator

Engineering definition of Risk, an example:


Probability of Accident
Risk =
Events Per Time Period

Consequence in Lost Money


Per Event

Yen Yee Chong and Evelynmay Brown: Managing Project Risk, Prentice Hall,
Pearson Education Limited, London, First Edition, Year 2000.
the management accountant, February, 2009

Cover Feature

Risk Measurement: In the words


of William Shockley measurement is a
comparison to a standard. The process
of measurement involves estimating the
ratio of the magnitude of a quantity to
the magnitude of a unit of the same type
(length, time, mass, etc.). A
measurement is the result of such a
process, expressed as the product of a
real number and a unit, where the real
number is the estimated ratio. It is true
that only quantifiable and identifiable
risks are managed in terms of providing
hedge cover or insurance. It is pertinent
that enterprises identify its key risks
and the volume of exposure, before it
could decide on the type of hedging
and its timings, to optimize risk-return
payoff. Range, Standard Deviation, Coefficient of Variation and other
Econometric tools are used for the
measurement of risk.
Risk Management: is the process
of identifying, analyzing and evaluating
the risk and selecting the best possible
methods for handling it. There is no
standard approach for risk management.
However, there are some common
elements of successful risk management
efforts: (i) Recognition of the risk is the
responsibility of a programme
management, (ii) The risk management
process includes planning for risk
management, continuously identifying
and analyzing programme events,
assessing the likelihood of their
occurrence and consequences,
incorporating handling actions to
control risk events and monitoring a
programmes progress towards meeting
programme goals. In an ideal risk
management, a prioritization process is
followed whereby the risks with the
greatest loss and the greatest
probability of occurring are handled
first, and risks with lower probability of
occurrence and lower loss are handled
later. In practice the process can be very
difficult, and balancing between risks
with a high probability of occurrence
but lower loss vs. a risk with high loss
but lower probability of occurrence can
often be mishandled. Risk management
faces a difficulty in allocating resources

properly. This is the idea of opportunity


cost. Resources spent on risk
management could be instead spent on
more profitable activities. Again, ideal
risk management spends the least
amount of resources in the process
while reducing the negative effects of
risks as much as possible.
Objectives: The main objectives of
the study are:
a. To explain the concept of risk, risk
measurement and risk management.
b. To discuss the different types of risk.
c. To analyze the techniques of risk
measurement.
d. To suggest the steps involved in the
risk management process.
e. To present the summary of the
study.
Types of Risk:
Number of factors will influence the
risk and depending upon the cause, the
risk can be broadly classified into the
following three major types:
1. Strategic Risks,
2. Operational Risks and
3. Investment Risks.
Strategic Risks: These risks are the
issues which require companies to think
on a large scale. These risks have a
major impact on the companys costs,
prices, products and sales. Some of the
solutions which companies bring to
bear such risks are shown in the
following table:
Operational Risks: These risks can
be categorized according to their
occurrence. Some occur at suppliers,
others at the point of production, in the
distribution chain or when the product

Strategic Risks
Government and
Economic Factors
Customers
Competitors
New Technology

the management accountant, February, 2009

is consumed. Operations risk stems


from a variety of sources.
Broadly speaking, these are process
risk, people risk, technology risk and
disasters. Each of these categories must
be investigated to identify the risk
elements, assign a probability of
occurrence, consequences if the event
did happen and thus arrive at the
weightage assigned to that risk.
Operational hazards classified by time
are presented in the following table:
Some of the Important Operational
Risks are Presented in Brief:
Process Risks: this stem from the
design of the process and the extent of
manual or human element in the steps
of the process. A common risk is
incorrect data capture. Since data
capture is often the very first step in a
process, an error there has
consequences in all the succeeding
steps and rectifying the error in turn
involves many stages of rollback. Data
capture can easily be classified as a risk
with a high probability of occurrence
and with costly consequences, thus
making it a high weightage risk.
People Risk: this risk is rarely
considered as a formal risk. At the back
of his mind, a manager is probably aware
that there is excessive dependency on
one person, but this also means that he
is too busy to train someone else. A
formal identification of key persons and
a strategy to contain that risk is
essential. Likewise, formal process
documentation, recruitment, induction,
ongoing training and motivation
policies are very important to mitigate
those HR risks.

STRATEGIC RISKS
Have an impact upon the
Solutions can be found in
companys
Costs
Prices
Products
Sales

Strategic Planning of
Markets and Products
Empowerment
Quality Management
Customer Care
Investment Innovation
Cost Reduction
95

Cover Feature

Operational Risks
Suppliers
Interruption of
Supplies
Poor Quality
Supplies

Process and
Internal Risks
Fire
Pollution
Fraud
Computers
Accidents
Labor
Disputes
Terrorism,
Kidnap and Ransom

Technology Risks: the financial


industry is the leading user of
technology worldwide. Even in India,
banks, brokerages, exchanges and
mutual funds are aggressive users of
the latest technology. As technology
becomes a key part of the process, its
maintenance and performance becomes
a key risk factor. The risks associated
with the hardware side of technology
are somewhat easier to contain, because
they involve in simple monetary costs
in redundancies. Hardware and
networking skills are somewhat at a
premium, but these are generic skills and
can be had at a cost. The risk associated
with the application side is far more
insidious and difficult to manage.
Application technology is invariably
customized to that particular business
need.
Investment Risks:
Every investment involves
uncertainties that make future
investment returns risky. Some of the
sources of uncertainty that contribute
to investment risks are aggregated into2
(a) Interest Rate Risk (b) Purchasing
Power Risk (c) Bull-Bear Market Risk
(d) Default Risk (e) Liquidity Risk (f)
Callability Risk (g) Convertibility Risk
(h) Political Risk (i) Industry Risk (j)
Currency Risks (k) Portfolio Risk and
(1) Country Risk.
Interest Rate Risk: It is defined as
the potential variability of return caused
by changes in the market interest rates.
The degree of interest rate risk is related
to the length of time to maturity of the
96

Distribution

Customers

Counterfeiting

Payment Problems

Tampering

Changing
Needs Product
Liability

security. If the maturity period is long,


the market value of the security may
fluctuate widely. Further, the market
activity and investor perceptions
change with the change in the interest
rates and interest rates also depend
upon the nature of instruments such as
bonds, debentures, loans and maturity
period, credit worthiness of the security
issues, etc.
Purchasing Power Risk: This is the
variability of return an investor suffers
because of inflation. It is closely related
to interest rate risk, since interest rates
generally rise when inflation occurs.
Purchasing power risk is more relevant
in case of fixed income securities;
shares are regarded as hedge against
inflation. It is the risk that the real rate
of return on security may be less than
the nominal return. There is always a
chance that the purchasing power of
invested money will decline or that the
real return will decline due to inflation.
The return expected by investor will
change due to change in real value of
returns. Cost push inflation is caused
by rise in the costs due to rise in the
input costs. Push and pull forces operate
to increase prices due to inadequate
supplies and raising demand.
Bull-Bear Market Risk: It arises
from the variability in market returns
resulting from the operators of bull and
bear market forces. When a security
2

Jack Clark Francis: Investment Analysis


and Management, Me Graw-Hill
International Editions, Fifth Edition, p. .3.

Competitors
Competitor Activity

index rises fairly consistently from a low


point, called a peak, for a period of time,
this upward trend is called a bull market.
The bull market ends when the market
index reaches a peak and starts a
downward trend. The period during
which the market declines sharply
indicating a trough trend and the
position is called as a bear market.
Default Risk: Is that portion of an
investments total risk that results from
changes in the financial integrity of the
investment. It is a failure of the borrower
to pay the interest and principal amount
within the stipulated period of time. The
default risk has the capital risk and
income risk as its components. It means
not only failure to pay, but also delay in
payment.
Liquidity Risk: Is that portion of
an assets total variability of return
which results from price discounts given
or sales commissions paid in order to
sell the asset without delay. It is a
situation wherein it may not possible to
sell the asset. Assets are disposed off
at great inconvenience and cost in terms
of money and time. Any asset that can
be bought and sold quickly is said to
be liquid. Failure to realize with minimum
discount to its value of an asset is called
liquidity risk.
Callability Risk: It is that portion
of a securitys total variability of returns
that derives from the possibility that the
issue may be called as the callability risk.
Callability risk commands a risk premium
that comes in the form of a slightly
higher average rate of return. This

the management accountant, February, 2009

Cover Feature

additional return should increase as the


risk that the issue will be called creases.
Convertibility Risk: It is that
portion of the total variability of return
from a convertible bond or a convertible
preferred stock that reflects the
possibility that the investment may be
converted into the issuers common
stock at a time or under terms harmful
to the investors best interests.
Political Risk: It arises from the
exploitation of a politically weak group
for the benefit of a politically strong
group. With efforts of various groups
to improve their relative positions
increase the variability of return from
the affected assets. Regardless of
whether the changes that cause political
risk are sought by political or by
economic interests, the resulting
variability of returns is called political
risk if it accomplished through
legislative, judicial or administrative
branches of the government.
Industry Risk: It is that portion of
an investments total variability of
return caused by events that affect the
products and firms that make upon
industry. The stage of the industrys life
cycle, international tariffs and/or quotas
on the product produced by an
industry.
Currency Risks: These are
associated with international
investments not denominated in the
home currency of the portfolio
managers beneficiaries. These risks
involve the international payment of
cash. Currency risks on a global basis
may be close to unsystematic, meaning
that they are uncorrelated across
economies and are not priced.
Portfolio Risk: Portfolio managers
attempt to maximize returns given an
acceptable level of risk. Industry
practitioners describe five different
portfolio management risks as: interest
rate risk, liquidity risk, credit risk,
operating risk and currency risk.
Country Risk: It involves the
possibility of losses due to country
specific economic, political or social
events or because of company specific

characteristics, therefore all political


risks are country risk but all country
risks are not political risks. A sovereign
risk involves the possibility of losses
on private claims as well as on direct
investment. Sovereign risk is important
to banks whereas country risk important
to MNCs.
Risk Measurement:
Risk refers to variability. A variety
of measures have been used to capture
different facets of risk. Among them
more important ones are - Range,
Standard Deviation, Co-efficient of
Variation and Semi-Variance. Apart from
this, we also use - Sensitivity Analysis,
Breakeven Analysis, Simulation
Analysis, Decision Tree Analysis,
Value at Risk Analysis and Cash Flow
at Risk Analysis.
Sensitivity Analysis: With the help
of sensitivity analysis it is possible to
show the profitability of a project alters
with different values assigned to the
variables needed for the computation
(unit sales price, unit costs, and sales
volume). This analysis is frequently
used if, although the simple and
discounted methods of evaluation do
not show a satisfactory profitability, an
improvement is felt to be possible by
changing some of the variables.
Break-even Analysis: The financial
manager is interested to know how much
he should be produced and sold at a
minimum to ensure is called break-even
analysis and the minimum quantity at
which loss is avoided is called the
breakeven point.
Simulation Analysis: The decision
maker would like to know the likelihood
of occurrences. This information can be
generated by simulation analysis which
may be used for developing the
probability profile of a criterion of merit
by randomly combining values of
variables which have a bearing on the
chosen criterion.
Decision Tree Analysis: It is a
useful tool where sequential decision
making in the face of risk is involved.
This analysis is having the four
important steps. They are (i) identifying

the management accountant, February, 2009

the problem and alternatives, (ii)


delineating the decision tree, (iii)
specifying probabilities and monetary
outcomes and (iv) evaluating various
decision alternatives.
Value at Risk Analysis (VAR): It is
one of the proven and the most used
measures of risks by financial
institutions. VAR measure the likely
change in marked to market value of a
portfolio, at specified time periods with
certain confidence.
Cash Flow at Risk Analysis(C-far):
is specifically developed for nonfinancial organizations with cash flow
as variable. The following two features
of non-financial organization had
resulted in the development of C-far
model. Firstly, certain assets of nonfinancial organization could be
accurately valued at market prices.
Secondly, the risk free and continuous
future cash flows represent the value
of any non-financial organization.
Hence, cash flows are taken as proxy
for measuring risks. Cash flow at risk
measures the deviation of cash flows
from the expected volume. In other
words, it gives an idea as to how much
of cash flows the portfolio might lose in
a given time with given probability.
Risk Management:
Risk Management is the process of
identifying assets at risk, assigning
appropriate values, identifying threats
to those assets, measuring or assessing
risk and then developing strategies to
manage the risk (see the Chart-1). In the
Risk Management the following steps
are to be taken up to minimize the risk.
Step-1: Identification of Assets at
Risk: The first step in the risk
management process is to identify the
assets in support of critical business
operations. The assets could fall under
different groups which are physical/
tangible and conceptual assets.
Step-2: Valuation of Assets: The
assets so identified and grouped in the
previous step are to be valued,
categorized into different classes, such
as critical and essential.
Step-3: Identifying the Threats:
97

Cover Feature

Threats can be defined as anything that


contributes to the interruption or
destruction of any service/product.
Various threats can be grouped into
environmental, internal and external
threats.
Step-4: Risk Assessment: The
process of Risk Assessment includes
not only assessment as to the
probability of occurrence but also the
assessment as to the potential severity
of loss, if risk materializes. This will
assist in determining the appropriate
risk mitigation strategy, the residual risk
and investment required to mitigate the
risk.
Step-5: Developing Strategies for
Risk Management: Once risks have
been identified and assessed, the
strategies to manage the risk fall into
one or more of these four major
categories:
i) Risk Avoidance: Not doing an
activity that involves risk and losing out
on the potential gain that accepting the
risk might have provided.
ii) Risk Mitigation/Reduction:
Implementing controls to protect
infrastructure and to reduce the severity
of the loss.
iii) Risk Reduction/Acceptance:
Formally acknowledging that the risk
exists and monitoring it. In some
cases it may not be possible to take
immediate action to avoid/mitigate the
risk. All risks that are not avoided or
transferred are retained by default.
iv) Risk Transfer: Causing another
party to accept the risk i.e. sharing risk
with partners or insurance coverage.
Summary:
Risk measurement and management
is also one of the important functions
of the financial manager. In the
changing global environment his
decisions are affected in a big way. Risk
is the chance of future that can be
foreseen. Risk is classified into various
categories, like strategic risk,
operational risk and investment risk. For
the measurement of risk various
methods are applied. By using these
methods, the financial manager has to
98

CHART-1: RISK MANAGEMENT PROCESS:

take a decision for investment or some


other purpose. The management of risk
is an important aspect for the
continuation of business in the longrun. Finally, the profit or the future cash
inflows are depending on the present
decision which influence for a future
course of action.
References:
A.K. Seth: International Financial
Management, Galgotia Publishing
Company, New Delhi.
Frank H. Knight: Risk Uncertainty and

Profit, University of Chicago Press,


Chicago and London.

James C. Van Home: Financial


Management and Policy, Prentice-Hall
of India Private Limited, New Delhi.

Keith Redhead: Financial Derivatives,

Prentice-Hall of India Private Limited,


New Delhi.
Kit Sadgrove: The Complete Guide to

Business Risk Management, Jaico


Publishing House, Mumbai.
N.D. Vohra and B.R. Bagri: Futures and

Options, Tata Me Graw-Hill Publishing


Company Limited, New Delhi.
Prakash G Apte: International Finance,

Tata Me Graw-Hill Publishing


Company Limited, New Delhi.

Prof. V. Gangadhar: Investment


Management, Anmol Publications
Private Limited, New Delhi.

R.K. Mittal: Portfolio and Risk


Management, Rajat Publications, Delhi.

Yen Yee Chong & Evelyn May Brown:

Managing Project Risk, Pearson


Education Limited, London.q

the management accountant, February, 2009

Cover Feature

Risk Reporting: An Essence


of Risk Management
Subhajit Ghosh*
Corporate risk communication is important for the well functioning of companies
and long term trust can be generated by rationalizing and monitoring risks. But
risk management is impossible without risk reporting. Proper risk reporting
can successfully predict the volatility, sensitivity and fluctuations in future
market. Risk reporting which is the essence of successful decision-making depends
on disclosure incentives. The main object of this paper is to realize the essence of
risk reporting and to show how important role mandatory risk reporting
disclosure under specific accounting standard can play to prevent corporate
collapses.
Introduction & Background
he decision making process
involves consideration for risk
and return. As higher risk tends
to higher return, corporate managers
take unnecessary risks. In order to
monitor and minimize the risk there
should be a risk management
framework and thus the concept of risk
reporting has gained importance. Risk
reporting is a decision support system
which aims to provide risk information
in the form of risks assumed, their
effects on future cash flows and profits
and effects of various corporate actions
on the risk profile of the firm. As any
managerial activity is impossible
without information, risk management
process is also impossible without risk
reporting. Risk reporting is reporting of
all anticipated risks, their classification,
effects and consequences. Risk arises
when expected cash flow differs from
actual cash flow. When the probability
of realizing cash is on the lower side, it
creates a risky situation. Risk reporting
is expected to describe all these
probabilities of future anticipated cash
flows. So risk reporting can be defined
as probabilistic forecast disclosure. So
risk reporting is futuristic and subjective

*Lecturer, Accounting & Finance


Department of Commerce St. Xaviers
College, Kolkata

reporting. Financial reporting is


reporting of actual and verifiable
information. On the other hand elements
of variability and reliability may be
missing to some extent in risk reporting
as it reports future risks and
probabilities.
Theres no doubt that risk reporting
is key to helping risk management to
add value to organizations. Its a
question every amateur philosopher has
pondered: If a tree falls in the forest
and no one is there to hear it, does it
make a sound? Similarly, risk
professionals may well have found
themselves asking: If a risk is managed
and no one is told, is it actually being
managed? Of all the major
developments in risk management in the
past few years one element that in many
cases, stands between success and
failure is risk reporting. Perhaps the most
key application for risk reporting, in
terms of risk professionals, is
demonstrating the value that risk
management can bring to an
organization and ensuring that those at
the top understand and value risk. With
senior executives and boards
increasingly looking to realize return on
investment, risk reporting is becoming
increasingly important.
Risk reporting can unearth excessive
controls and smarter resource
allocation. Effective risk reporting,

the management accountant, February, 2009

particularly KPI [key performance


indicator] reporting linked to risks, might
show where controls are excessive in a
part of the business and may be scaled
back to enable those resources to be
utilized in other parts of the business
where controls may be less adequate.
Effective risk reporting may show where
risks appear to be concentrated in
certain parts of the business and
resources can be allocated to those
areas. Its also crucial to ensure that risk
reporting is not a one-way street. While,
ostensibly risk reporting is designed to
enable senior executives and the board
of directors to make informed business
decisions on the basis of accurate risk
information, it should also be linked back
to those at the coalface. When risk
reports are linked back to the business
and actually assist the business in
managing its resources, reducing its
expenses and enabling risk taking in a
controlled environment then effective
risk reporting is critical to the risk
management and operational process.
With this backdrop an attempt has
been made to analyze the role of risk
reporting to realize the volatility,
sensitivity and fluctuations in future
market essential to prevent corporate
collapses. The next section provides an
insight into the identification,
classification and importance of risk
reporting. The third section develops
the basis for ideal risk reporting. The
fourth section explains the role of risk
reporting to reduce the gap between
accounting and economic valuation.
The fifth section deals with the
relevance of risk reporting in accounting
standard keeping in mind the Indian
scenario. The sixth section concludes
the paper.
Importance, Identification &
Classification of Risk Reporting
Importance of Risk Reporting: A
transparent and fair risk reporting
system is essential for a company as it
is bound to disclose all material risks
that it faces and its risk management
99

Cover Feature

practices. Risk reporting has gained


importance after collapse of Enron
followed by other major corporate
failures. Risk reporting can hold
managers accountable for what they do.
If corporate boards are insistent, they
can hold the bull by the horns and make
the managers more responsible. There
must be a justification for what
corporate managers do and dont do.
So risk reporting has the following
importance:
l It can assist the board to discharge
its responsibilities as the company
can go for higher profit at lower risk.
l It helps in decision making at all
level.
l It can help the investors to evaluate
market situations and to build
optimum portfolio of securities.
l Lenders can be assisted in their
lending operations and policy
decisions.
l It can help a company in getting
better credit rating and assess to
cheaper sources of finance.
l It reduces information asymmetry
between managers and investors
leading to reduced agency cost.
Lower agency cost can reduce the
cost of capital and can increase the
basket of profitable investment
opportunities available to a firm.
l It can create a niche for the company
and can act as trendsetters for
others.
Identification of Risks:
The process of identifying the risks
of an organization is an important
exercise. The key persons of the
organization are expected to raise their
awareness about the risks in their dayto-day operations. Peter Drucker has
classified risks into four broad
categories:
(a) risk that is built into the very nature
of the business and cannot be
avoided.
(b) risk one can afford to take.
100

(c) risk one can afford not to take.


(d) Risk one cannot afford not to take.
Traditionally risks are classified as
hazard risk, financial risk, operational
risk and strategic risk. Hazard risks are
related to natural hazards, accidents, fire,
earthquake etc. Financial risks are
concerned with volatility in interest and
exchange rates, asset liability mismatch
etc. Operational risks are associated
with systems, process and people and
covers areas like succession planning,
failure of research and development
facilities, non-compliance of regulatory
provisions etc. Strategic risks arise from
inability to adjust to changes in the
environment arising from merger or
acquisition, competition threats etc.
Indian companies have reported various
risks faced by them and most common
of these are financial risks related to
volatility in interest and foreign
exchange rates. Every type of risk arises
either from external factors like exchange
rate fluctuations, political environment,
competitive environment, inflation,
immigration regulations, technology
obsolescence etc. or from internal
factors like liquidity and leverage,
contractual compliances, intellectual
property management, integration and
collaboration, human resource
management etc.
Classification of Risk Reporting:
Risk reporting can be internal and
external or voluntary and mandatory.
Internally the corporate board and
other higher authorities expect a detailed
analysis of corporate risks and their
effects. Such information can be utilized
as risk monitoring and decision making
mechanism. Internal risk reporting is
mandatory. On the other hand external
reporting is done to inform the
stakeholders about the risk faced by the
entity, steps taken to mitigate and
control the risk and the mechanisms
adopted to facilitate decision making at
individual and institution level. External
risk reporting can be voluntary or
mandatory. Many feel that voluntary risk

reports do not yield desirable reports


and it is poor because:
l A manager is not under any legal
compulsion to disclose all the
details.
l He/she is not informed about all
risks.
l Lacks incentive to know or identify
all the risk factors.
l Does not believe in what is being
disclosed to him.
l Believes that they are only halftruths.
l Users are not serious users.
l Assumes that the users lack
sufficient skills to understand what
is being disclosed.
In view of all these, it can be said
that risk reporting should be made
mandatory. However, empirical evidence
shows that even under a mandatory
risk-reporting regime, comprehensive
risk reporting is rather vague providing
dissatisfying information content.
Developing the basis for ideal Risk
Reporting
The information that investors like
equity or debt holders, wish to have
about the financial performance of a firm
can guide their decision-making. They
would surely wish to form a view about
the firms past and current profitability,
solvency and liquidity at a given point
in time. No doubt, they would also like
to develop a picture of the risk profile
of those attributes over time and hence
of their potential future evolution. And
they would presumably also wish to get
a sense of how reliable or accurate those
measures are. Combined, these three
elements would provide the raw material
to inform views about expected returns
properly adjusted for risk and for the
inevitable uncertainties that surround
measurement. Three types of
information correspond to the key
categories into which the ideal set can
be divided namely: first-moment
information, risk information and
measurement error information.

the management accountant, February, 2009

Cover Feature

First-moment
information
describes income, the balance sheet and
cash flows at a point in time. It is by far
the type of information with the longest
tradition in accounting; it is, in fact, the
type with which accounting has often
been identified. In historical cost
accounting, much of this information is
of a contemporaneous or backwardlooking nature. However, even
according to this valuation principle, it
would inevitably include forwardlooking elements too, whenever the
valuation of an item is based on
expectations about the future. This is
true (implicitly) at inception, when the
transaction occurs. But it can also be
true in subsequent periods, whenever
the value of an item is adjusted based
on some estimate of future cash flows,
and the earnings figure is seen as the
period-to-period change in those
estimates. For example, loan loss
provisions are based on future
discounted cash flows. More generally,
forward looking elements are inherent
in accruals adjustments. By contrast, the
forward-looking component is intrinsic,
for instance, fair value accounting. It is
implicit to the extent that market values
embody such expectations. It is explicit
whenever models are used to derive
fair values.
Risk information is fundamentally
forward-looking. Future profits, future
cash flows and future valuations are
intrinsically uncertain. Risk information
is designed to capture the prospective
range of outcomes or statistical
dispersion for the variables of interest
as measured at a particular point in time.
More specifically, to the extent that the
behaviour of these variables can be
represented by probability distributions, risk information would ideally
provide the best estimate of the
corresponding
(unconditional)
probability distributions. Value-at-risk
or cash-flow-at-risk measures, for
example, are summary statistics of such
estimated probability distributions of

future outcomes. But one should


include in this category also information
that is not so easily captured by
probability measures, such as the
outcome of stress tests and sensitivity
analyses. Importantly, any such
directional information, which indicates
whether firms are long or short specific
risk factors, could also help to assess
the potential co-variation in
performance measures across firms,
particularly relevant to allow investors
to assess the degree of diversification
in their portfolios.
Measurement error information
designates the margin of error or
uncertainty that surrounds the
measurement of the variables of interest,
including those that quantify risk. The
need for this type of information arises
whenever these variables have to be
estimated. For instance, measurement
error would be zero for first-moment
information concerning items that were
valued at observable market prices and
for which a deep and liquid market
existed. But it would be positive if, say,
such items were traded in illiquid
markets, since a number of assumptions
would need to be made to arrive at such
estimates.
Measurement error information is even
less developed, although significant
improvements have been made or
proposed more recently. Firms generally
provide estimates of first-moment and
risk information as if they had no

uncertainty attached to them. One


important long-standing exception to
this common practice is that sometimes
firms have disclosed additional
information about the assumptions that
underlie the estimates, possibly
accompanied by sensitivity analysis. In
addition, the disclosure of a comparison
of previous forecasts with actual
outcomes remains very unsystematic.
While the broad thrust of the steps
taken in recent years towards greater
disclosure of risk and measurement error
information is very welcome, arguably
the state of affairs still falls short of what
is desirable and feasible. There are a
number of reasons for this:
First, unless it is assumed that market
participants somehow see through
the information provided in financial
statements and reach for any missing
elements, the information disclosed
does not as yet seem sufficient to form
a proper view of the potential benefits
and risks of investing in a firm.
Second, the changing composition of
the investor base lends further support
to the need to go beyond first-moment
information. It has sometimes been
argued that the emphasis on firstmoment information is a natural result
of the focus on the needs of equity
holders.
Third, historical experience suggests
that a key objection to the disclosure of
information, namely proprietary
concerns, can easily be exaggerated. In

The Ideal Information Set (Table 1)


Financial Characteristic
First-moment information

Risk information

Measurement Error

the management accountant, February, 2009

Illustrations
l Income statement
l Balance sheet statement
l Cash flow statement
l Earning-at-risk and
value-at-risk
l Portfolio stress test
l Sensitivity analysis to
parameter values
l Comparison of outcomes with
previous estimates

Availability
Very high

Medium

Low

101

Cover Feature

particular, the set of what has been


regarded as private information has
steadily been shrinking. For instance,
information was initially limited to the
balance sheet rather than earnings; and
when earnings information became
public, revenue information was
originally regarded as proprietary.
Fourth, measurement technology
has already proceeded to a point that
additional meaningful information could
be supplied, at relatively low cost.
Advances in measurement technology
over the last 30 years or so have been
enormous.
Fifth, the process of edging closer
towards the ideal information set should
be seen as evolutionary and as tailored
to the characteristics of reporting
entities. It should be seen as
evolutionary because it is important
that progress be made at a measured
pace consistent with the developments
in, and the spreading of, risk
measurement technology. Finally, and
more generally, valuations are
fundamentally affected by risk and
uncertainties and by attitudes towards
risk, as captured by risk premia.
Therefore, first-moment, risk and
measurement error information are
inextricably linked. The quality of firstmoment information itself is dependent
on the quality of risk and measurement
error information. As an accounting
framework for first-moment information,
which incorporates more forwardlooking elements, is developed, the
importance of risk and measurement
error information will inevitably become
more obvious.
Risk Reporting and the gap between
Accounting and Economic valuations
It is now time to explore in more
detail the factors that can lead to a gap
between accounting valuations, on the
one hand, and underlying economic
valuations, on the other, and how this
gap might be narrowed. Greater
consistency with sound risk
102

management can help to bridge the


divide.
The most controversial issues
giving rise to tensions between the
accounting standard setters, risk
managers and prudential supervisors
often arise precisely for the same
reasons. We can consider the following
implications:
First, the definitions of assets and
liabilities may not necessarily include
all the cash flows that the firm (or the
market) considers when making
decisions; typically, in fact, they are more
restrictive. Examples: intangibles,
growth options, and, more generally,
cash flows associated with anticipated,
but as yet not contracted, income
streams. Depending on the
predictability of such cash flows, the
firm may understandably wish to take
them into account in its business and
hedging decisions. Accounting
standard setters, however, may not find
it consistent with their framework.
Second, even if the asset/liability
meets the relevant accounting
definition, it might not meet the
standards for recognition on the
balance sheet. Failure to recognize
internally generated intangibles is a clear
case in point. In this case, the results
are analogous to those where the
accounting definitions do not
correspond to those effectively
employed in the running of the business.
Finally, in economic and
reported values, a gap may arise from
the use of different valuation principles
for different items in the balance sheet.
The most common source of such
mismatches is the current mix of
historical and fair value principles
applied to the accounts.
Factors for such discrepancies: One
factor may simply be the piecemeal
evolution of the accounting standards,
particularly relevant in relation to
aspects of the coexistence of different
measurement attributes, such as
historical and fair-value elements.

A second factor relates to specific


aspects of the definitions. For instance,
an entity should have a sufficient
degree of control over the cash flows
associated with an asset before the item
is deemed to meet the definition of an
asset and past transactions and
events have to be clearly associated
with its control. More fundamentally
perhaps, a third factor relates to the
degree of verifiability of the cash flows
associated with the assets (liabilities).
Indeed, issues of control or the stress
on the relevance of past transactions
and events may arguably at least partly
be traced to difficulties in verifying the
corresponding cash flows, especially
when future cash flows are involved.
The gap between accounting and
closer approximations to underlying
economic valuations can clearly distort
the accounts and, in a world of imperfect
and costly information, also economic
behaviour.
A second, even more widespread,
concern is that the mismatch can result
in artificial volatility in net worth and
income measures, i.e, volatility that in
some sense does not reflect underlying
economic volatility. On the one hand,
this artificial volatility could distort the
behaviour of investors, unnecessarily
increasing financing costs. In some
sense, the firm would be perceived as
artificially risky. On the other hand, it
could encourage inappropriate hedging
practices, as the firm came under
pressure to hedge the volatility in the
accounting numbers as opposed to the
one that might be closer to the
underlying economic volatility
associated with the economic substance
of the transactions. The complex
apparatus of hedge accounting is
precisely aimed at limiting the effects of
the mismatches on the volatility of the
balance sheet and the income
statements arising from mixed-attribute
accounting. This measured volatility
would still exist, but would be smaller, if
only entity-specific and fair values

the management accountant, February, 2009

Cover Feature

coexisted in the same framework,


because of the different inputs. The
accounting standard seems to be going
in this direction. But the volatility would
not be eliminated completely even in a
full fair value arrangement.
Revealing illustrations of the
potential tensions between accounting
and firms perspectives on valuation
and volatility arising from definitional
and recognition issues include the
treatment of demand deposits, which
has attracted much attention in recent
years. For the purposes of business
planning and risk management, financial
institutions have been accustomed to
treat the corresponding instruments on
the basis of their behavioural
(expected), as opposed to
contractual, maturity, with this
(statistically) expected maturity being
estimated with reference to historical
patterns. This has obvious implications
for the hedging of interest rate risk, as
actual maturities are much longer than
contractual ones, especially if the latter
are interpreted as the shortest time
interval within which the withdrawal/
cancellation option can be exercised.
Lets consider the case of demand
deposits. The accountant would treat
the deposits individually. And would
consider each deposit as the
outstanding balance at a point in time,
with potential future additions and
withdrawals even by the same
depositor representing new, future
transactions over which the institution
has no control. As such, these
transactions would be excluded from
consideration, as not meeting the
definition of an outstanding asset/
liability. The corresponding expected
maturity of the deposit would then be
very short, days, weeks or months rather
than years. In contrast, the perspective
of the firm is entirely different. Even for
a single deposit account, it would
consider the average balance as being
the relevant criterion. Moreover, it
would tend to focus on the whole stock

of deposits at a point in time across all


deposit holders, normally even
offsetting the transactions of new
depositors against those done by old
depositors. The resulting expected
maturity of the deposit base would be
quite long, typically years. In fact, banks
regard such core deposits as one of the
most stable sources of funds at their
disposal.
This suggests that it would be
desirable to seek to close the gap
between the way these issues are dealt
with in the accounting and in the
internal running of the firm. It seems to
us that the economic substance of the
transactions is closer to the latter than
to the former. The risk is that prudent
economic hedging may be discouraged
at the expense of uneconomic hedging
aimed exclusively at accounting
numbers and that, more generally,
information signals may be distorted.
How exactly this could be done is not
clear. The possible solutions do depend
on detailed interpretations of definitions
and concepts and also on potential
knock-on effects on other parts of the
accounting framework. But the general
direction is clear: paying closer
attention to consistency with sound
risk management practices and risk
reporting holds useful clues about how
to narrow the gap. It is clearly unrealistic
to expect that the needs of accounting
and risk management could be fully
reconciled. Tensions are bound to
remain as a result of differences in the
objectives and degrees of freedom in
the two disciplines. Questions of what
can and cannot be recognized as assets
and liabilities, based on criteria such as
the verifiability of the corresponding

amounts, are an obvious example. Even


so, there seems to be considerable
scope for a narrowing of the gap
between the two perspectives. It is
desirable to strengthen efforts to this
end.
Risk reporting and consistency of
Accounting Standards:
Though risk reporting is gaining
importance in the edge of global
integration of business and stock
markets, emergence of derivatives and
other risk products, increasing
corporate failures still there is no
specific accounting standard issued
either by the IASB or by the FASB. Each
of these agencies has risk reporting
disclosure requirements under specific
accounting standards. Among various
IASs and IFRSs issued by the IASB,
the IFRS-7 on Financial Instruments:
Disclosures covers the disclosure of
nature and extent of risks arising from
financial instruments. Similarly IFRS-4
on Insurance Contracts prescribes the
disclosure requirements in insurance
contracts. An insurer should disclose
information relating to companys risk
management policies and objectives,
insurance risk, interest rate and credit
risk, exposure to interest rate or market
risk under embedded derivatives that
are contained in a host of insurance
contracts.
IAS-1
encourages
enterprises to present, outside financial
statements, a financial review by
management, which should describe and
explain the main features of the
enterprises financial performance and
financial position as well as principle
uncertainties it faces. IAS-21
encourages the disclosure of an
enterprises foreign currency risk

Narrowing the Gap: Demand Deposits (Table 2)


Unit of analysis
Future changes in balance
Maturity
Impact of a rise in market
rates on valuation

the management accountant, February, 2009

Accounting
Individual basis
Excluded
Very short
Zero (face value)

Risk Management
Portfolio basis
Included (statistical basis)
Long (behavioural)
Fall (profit)

103

Cover Feature

management policies. IAS-37 requires


the information is provided about risks
for which provisions have been
recognized in the balance sheet. For
each class of provision an enterprise
should provide a brief description of the
nature of the obligation and the
expected timing of resulting outflows
of economic benefits as well as
uncertainties about the amount or
timing of those outflows.
In India, ICAI, like IASB, is yet to
pronounce an independent accounting
standard on risk reporting. Like IFRSs
and IASs, the Indian Accounting
Standards very cursorily deal with some
of the risk aspects. AS-11 (Revised) on
The effects of changes in foreign
exchange rates and exposure draft on
Presentation of financial instruments
deal with risk reporting only to a little
extent. AS-11 expects companies to
disclose their foreign exchange risk
management policies and framework.
The German Accounting Standards
Board issued GAS-5 on Risk
Reporting in 2000, which was
applicable from 31st December 2000. The
standard is applicable to all parent
organizations, which are either limited
liability companies or enterprises
equivalent to such companies and to
enterprises, which are required to
present consolidated financial
statements. The standard prescribes
that information should be presented
in a self contained section of the group
management report.
Risk reporting is based on following
criterion:
Criterion I Reliance on PrinciplesBased Accounting Standards:
In general, the principles-based
IFRS framework seems particularly welltailored to international implementation.
Legal, tax and regulatory environments
differ from one country or economic
area to another, so that the flexibility
provided by a principles-based
104

approach seems highly suitable.


Although the trend towards increasing
financial integration reduces those
peculiarities,
principles-based
standards fit better to this type of
situation. The IFRSs set out general
principles, which include examples or
application guidance, but without
presuming to capture every kind of
operation in a specific rule. Hence,
accountants and auditors are left room
for judgement and adaptation under the
IFRSs. However, the IFRS framework
appears to be relatively prescriptive, i.e.
much closer to a rules-based approach,
in the specific area of financial
instruments (i.e. IAS 39). Indeed, if
hedge accounting is taken as an
example, institutions need to comply
with a strict set of requirements. Given
the possibility of deferring or bringing
profits or losses forward, it is
understandable that the IASB has come
to the conclusion that this discretion
be governed by stricter and detailed
rules. Nevertheless, there is some
inconsistency with the global
principles-based approach, which could
also create complex implementation
issues.
Criterion II Use of Reliable and
Relevant Values:
For instruments or operations that
have a short time horizon and that are
traded in active, deep and liquid
markets, historical cost is close to
meaningless and the reliability and
relevance of market or model values is
not questioned. These market values
are easily determined from observable
market prices, which should incorporate
all relevant information, or from widely
accepted models that mainly use
observable market inputs. Hence, in this
context, market or model values do,
indeed, provide appropriate signals for
economic decisions. However, concerns
arise upon departure from that stylised
set of assumptions. Moreover, liquidity

may also vary over time, depending on


current economic conditions.
Unexpected or sudden developments
could also rapidly affect the liquidity of
operations within an economic sector.
In a nutshell, marking-to-market
values are not always a synonym for
fair values. Limitations or difficulties
can arise when valuing, for example, (i)
tailored or complex products that
cannot be priced through generally
accepted models or that require
unobservable inputs for pricing, or (ii)
long term financial instruments that are
extremely sensitive to the underlying
parameters, i.e. cases where a marginal
change in one of the models parameters
results in a material change in the value.
IFRS 7 (Financial Instruments:
Disclosures) may partially address this
issue as firms have to disclose the
consequences of probable changes in
the parameters, but the bottom-line
figures will remain subject to this pricing
fragility.
Criterion III Recognition of the
Allocation and Magnitude of Risks:
The IFRSs should improve the
information pertaining to the financial
position of the bank, as the accounting
standards require a more comprehensive
recognition of risks in the balance sheet.
Indeed, all derivatives will have to be
reported in the balance sheet at their
fair value. This is a significant and highly
welcomed improvement over the rules
previously existing in most European
countries, where derivatives not held
for trading were kept off-balance-sheet
at cost, thus concealing the effective
risks incurred. The IFRS rules for derecognition and consolidation could
also have a favourable impact as they
seem adequately to reflect effective risk
exposures in most situations. Indeed,
the IFRS approach for de-recognition
mixes a risk-and-reward approach,
which tends to precisely track the
economic allocation of risks, with a

the management accountant, February, 2009

Cover Feature

control-oriented approach, while giving


precedence to economic substance over
the legal form. Such rules could be
regarded as particularly helpful both in
a context where risk transfers are
developing between banks, on the one
hand, and insurance companies, mutual
funds, hedge funds and pension funds,
on the other, and with a view to the
potential financial stability implications
if unidentified risks were to emerge.
Criterion IV Provision of Comparable
Financial Statements:
The adoption of common
accounting standards in Europe as such
means a major improvement in the
comparability of financial statements. In
principle, the introduction of the IFRSs
provides a substantial increase in
comparability and transparency. An
analysis of the current situation in
Europe, however, leads to the
observation that this benefit has not
been fully reaped, as implementation of
the IFRSs appears, discussions with
market participants showed differences
in the implementation of the IFRSs, in
particular on account of strong domestic
accounting cultures and divergent
positions among external auditors
across jurisdictions. In this context, the
IFRSs should not cover provisions, nor
should their implementation create
ambiguities that could jeopardize the
objective of enhanced comparability.
However, certain provisions of the
IFRSs, notably IAS 39, considers
financial instruments that are effectively
exposed to credit risk, thus excluding
other financial instruments such as
government bonds from the argument.
For the purpose of measurement, IAS
39 groups financial instruments into
four categories that are based on
management intent. The intent behind
managements holding an instrument is
also used as the determining factor in
existing local European rules. It is thus
an accepted accounting convention

that different values can appear in the


balance sheet for similar financial
instruments, depending on the nature
of, or intent behind, their use. It is also
consistent with the objective that
accounting should be aligned to sound
risk management practices. However,
some aspects of IAS 39 may raise
concerns about comparability insofar as
it permits identical or similar positions
that are managed in the same way to be
accounted for differently.
Criterion V Alignment of Accounting
Rules with Sound Risk Management
Practices:
When comparing international
accounting rules with sound risk
management practices, three main
issues arise regarding trading,
provisioning and hedging. With regard
to trading, marking-to-market or
marking-to-model measurements, when
appropriately calculated, provide senior
managers and, eventually, stakeholders
with very useful early warning signals
on exposures. The immediate impact on
profitability is generally a strong
incentive to adequately manage
exposures. This anticipatory effect can
be considered a sound risk management
tool on an individual basis. Where
provisioning is concerned, accounting
should ideally incorporate a pro-active
approach that is comparable to sound
credit risk management, which tries to
identify expected collective losses as
soon as possible, in particular those that
may be embedded in loans and relate to
sectoral, geographical or even global
monetary and other economic
developments, be they existing or
anticipated. With regard to hedge
accounting, the IFRSs should reflect the
economic substance of the
transactions. Despite improvements
introduced to IAS 39 (Financial
Instruments: Recognition and
Measurement) that bring hedge
accounting closer to the risk

the management accountant, February, 2009

management methods used by credit


institutions.
Criterion VI Promotion of a ForwardLooking Recognition of Risks:
Two issues could be considered in
this context: (i) the forward-looking
nature of fair value accounting and
(ii) the incorporation of forward-looking
elements in the provisioning of
instruments measured at amortized cost.
Fair value accounting could be regarded
as forward-looking by nature, given that
expectations regarding the future
performance of assets and liabilities
should, in theory, be reflected in market
valuations. Indeed, fair value leads to
the revaluation of an asset when there
is a change in its market price or (in the
absence of a market for the asset) in the
present value of the future stream of
cash flows to be generated by the asset.
Risk Reporting Disclosure: The Indian
Scenario
In spite of making it compulsory for
all listed companies in India to disclose
(in their report of Board of Directors)
the risks faced and the adequacy of risk
management processes in their
organizations, the quality of such
disclosures are not satisfactory. Except
for some of the leading software
development companies, not many
Indian Companies have recognized the
importance of integrated risk
management. Most of the companies
are adopting defensive approach to
minimize the negative impact of risk.
Even in banks and financial institutions,
where success largely depends on
striking a balance between enhancing
profits and managing risk, the attention
to risk identification, measurement and
monitoring is not adequate. This is
evident from the quality of their risk
reporting and disclosures. Mathematical modeling and sensitivity
analysis, which indicate how much the
company will be affected by risk
exposure, is missing in the disclosures.
105

Cover Feature

State Bank of India, the largest public


sector bank of the country, in it report
covers some of the risks it is exposed to
and looks for dealing with them through
internal control, audits and adhering to
RBI guidelines. The bank is now looking
for designing, monitoring and
implementing an appropriate structure
for integrated risk management. Many
of the banks have constituted Asset
Liability Management Committee
(ALCO) to evolve optimal asset/liability
structure on going basis and Operations
Risk Management Committee (ORMC)
to oversee operational risks and the
requisite control measures. The banks
do not seem to have quantified risk
impact. Hero Honda Ltd., a leading auto
sector company, in its report has
mention of slow down, competition and
input costs as its risk. This is more like
general statements about the risks to
theoretically comply with the reporting
requirements. Similarly, ACC Ltd., a
leading cement manufacturing
company, has just touched upon the
availability of coal and transport
bottlenecks as the likely risk factors to
the company. The company is looking
towards the government for necessary
steps to improve the situation. NTPC
Ltd., another leading public sector
company, has reported some of the risks
it is exposed to and is relying upon the
systems and practices put in place since
its inception for identification and
mitigation of risks. Wipro Ltd. in its latest
annual report has dealt with various
types of risks in great details covering
microeconomic, geo-political, social
and international developments such as
taxation and foreign investment
policies, regional; conflicts in South
Asia, political instability, unauthorized
use of intellectual property rights,
presence in market segments, cost
management, competitive forces,
immigration policy, technology
adaptation,
telecommunication
disruptions etc. However, sensitivity
analysis is absent.
106

In India risk management framework


has been made mandatory by SEBI as a
result of The Narayana Murthy
Committee recommendation.
Conclusion & Recommendation
Risk reporting is the essence for
adopting risk management framework,
to curb with the increased failure rate of
corporates and to comply with
stakeholders expectations. Through
risk reporting fairness and transparency
principles dictate corporate actions. On
the basis of above discussions,
following recommendations can be
made:
l By offering greater transparency
and risk-oriented reporting, the
IFRSs may provide early warning
signals on exposures or risks.
l In order to accommodate the
increased complexity and the fast
pace of innovation that dominate
the financial sector, accounting
standards should preferably be
principles based, which is generally
the case for the IFRSs. They should
also reflect operations, and not only
the different types of financial
instruments used.
l High-quality accounting standards
are important for financial stability
and should not merely represent a
starting point for regulators and
supervisors, which would require
further adjustments. Appropriate
accounting standards remain
necessary, and wherever possible
consistency should be achieved.
l As a result of an instrument-based
approach, IFRS hedging techniques
can be regarded as very complex, to
the extent that they are confusing
even for banks and stakeholders,
including financial analysts.
Furthermore, the accounting
standards do not seem to always
address all the needs of sound risk
management.
l The economic maturity of demand
deposits is not acknowledged

within the current IFRS framework,


thus making hedging of these
resources difficult. Financial
statements in a principles-based
framework should preferably reflect
the
underlying
economic
substance.
Consolidation and de-recognition
rules under the IFRSs go in the right
direction as they tend to correctly
identify where the actual risks are,
which should promote proper risk
management and effective market
discipline.
The publication of enhanced
financial disclosures strengthens
market discipline.
The reliability of fair values is a
very important issue from a financial
stability perspective. Financial
instruments should be measured
accurately and conservatively.
The hedge accounting regime
should adequately take into account
sound and strictly documented risk
management practices, which would
help to mitigate risks
From a financial stability point of
view, the provisioning regime for
loans needs to be sufficiently
forward-looking to reduce the risk.
A number of IFRS guidelines
present positive features from a
financial stability perspective (e.g.
principles-based rules, recognition
of risks versus formal accounting
based on legal aspects, the
conditions under which to use the
fair value option, the day-one profit
measurement issue). These features
are of paramount importance and
should not be forsaken in the future,
for instance, within the context of
the international convergence
project.
Accounting governance should be
strengthened. In this context,
ensuring the reliability and quality
of external audits is of paramount
importance in the implementation of
principles-based standards.q

the management accountant, February, 2009

Cover Feature

Operational Risk: An
Important Issue in
Modern Banking
Operational risk of banks is really a tough task to quantify and the nonavailability of data due to operational loss makes the task tougher. The revised
accord for regulating banking risk, known as BASEL-II, has given a new
dimension to the measurement procedure of this risk. This paper focuses on the
problems in the measurement procedure as suggested by BASEL-II in Indian
banks and the steps to be taken to overcome such problems.

Soumya Mukherjee*
Introduction:
isk is part of business lexicon
and understanding and
subsequently managing it is the
most difficult task for all organisations.
Like other organisations, management
of risks is also an important issue in
modern banking. The increased
pressure of globalization and severe
competition in the global economy has
forced the banking sector to redesign
their strategies regarding risk
management. Banking sector is exposed
to three types of risk e.g. credit risk,
market risk and operational risk.
Market risk arises due to assetsliability mismatch and exposure to
foreign currency transaction. Proper
management of market risk is very
essential in India because of our
increasing integration with the global
markets and also for the greater
frequency of economical and political
shocks.
On the other hand, credit risk arises
from lending activities of a bank e.g.
when a borrower does not pay the
interest and/or instalments as and when
it falls due, it leads to the conversion of
performing assets into non-performing
assets. The high incidence of non-

*Lecturer, Maharaja Manindra Chandra


College, Kolkata.

performing assets in many banks


balance sheet reinforces the
significance of credit risk.
To control these two risks banks
have chosen many procedures such as
use of more highly automated
technology, application of e-commerce,
online data transfer, outsourcing,
greater use of financing techniques etc..
Undoubtedly, these procedures reduce
market and credit risk but due to immense
use of these procedures, the operational
risk increases substantially and in the
last couple of years banking industry
has perceived the behaviour of
operational risk in shaping risk profile
of the bank. Infact, banking industry is
currently undergoing a surge of
innovation in controlling and mitigating
operational risk.
Meaning and Classification of
Operational Risk:
Operational risk arises primarily due
to deviation from planned normal
functioning of system, procedures,
technology, human failure, omission or
commission of errors. It also arises due
to inherent fault in the systems,
procedures and technologies that affect
the revenue of the organisation
adversely. As the activities of the
organisation change due to
globalization and integration, new
factors are continuously influencing

the management accountant, February, 2009

and increasing the operational risk.


For regulating the risk of the banks,
an internationally active committee was
formed, known as BASEL Committee on
Banking Supervision (B.C.B.S.). Over
the past few decades, they have issued
the accord for controlling and mitigating
risk of the banks. The revised accord
for regulating banking risk issued by
them is known as BASEL-II.
As per BASEL-II Accord - 644
operational risk is defined as the risk
of loss resulting from inadequate or
failed internal process, people and
system or from external events. This
definition includes legal risks but
excludes strategic and reputational
risk. *1
The last sentence of the above
definition is included later on and the
legal risk is not limited to exposure to
fines, penalties or punitive damages
resulting from supervisory activities as
well as private settlements. Hence, legal
risk can arise due to any sort of violation
of legal rules. This definition focuses
on the causes of operational risk and
the BASEL Committee believes that this
is appropriate for both risk management
and its proper measurement. The
second consultative paper of BASELII suggests classification of operational
risk based on cause and effect *2.
In addition, the third consultative paper
recommended for eventbased
classification *3.
Identification and Measurement of
Operational Risk:
Operational risk identification and
measurement are still in evolving stages
as compared to credit and market risk.
The basic theme of all measurement
approach is same i.e. to hold capital
charge (or capital allocation) for risk
mitigation. Capital allocation means
*1

[BASEL-II Accord (bis.org)]

*2

( Risk Management- published by I.I.B.F,


Year 2005 )
*3
(Working paper on regulatory treatment
of operational risk (September 2001))

107

Cover Feature

These are shown in the following diagram-

Based on causes

Based on effects

Based on events

People oriented cause

Legal liabilities

Internal fraud

Process oriented cause

Regulatory compliance

External fraud

Technology oriented

and taxation penalties

Employment practice and

cause

external cause

customers

Other physical and

work place safety

Loss or damages to the

Clients, products and


business practices

Restitution

Damages to physical
assets

Business disruption and


system failure

Execution delivery and


process management

setting aside a portion of capital for


mitigation of risk. Basel-I accord and the
1996 amendment did not include
operational risk factor for capital
requirement but the Basel-II accord
defines the capital requirement as
Capital= Minimum capital ratio (8%)
X [credit risk X market risk X
operational risk]
It has also provided three options
in the measurement of operational risk
for the purpose of capital allocation.
They are
I. Basic Indicator Approach
II. Standardised Approach
III. Advanced Measurement Approach
Basic Indicator Approach:
The most basic approach allocates
operational risk capital using a single
indicator as a proxy for an institutions
overall operational risk exposure. Gross
income is proposed as the indicator,
with each bank holding capital for
operational risk equal to the amount of
a fixed percentage, , multiplied by its
individual amount of gross income. The
108

Basic Indicator Approach is easy to


implement and universally applicable
across banks to arrive at a charge for
operational risk.
Banks using Basic Indicator
Approach must hold capital equal to
15% of the gross positive annual
income of the previous three years. For
any year if the gross income is negative
or zero, the figures should be eliminated
from both the numerator and
denominator while calculating the
average. The capital charge for
operational risk may be expressed as
follows
KBIA =

[ (G.1.1.....n )1.
n

Where KBIA = capital charge under Basic


Indicator Approach
G.I. = Annual gross income, where
+ve over past three years
n = Number of previous three years
for which gross income is +ve
a =A coefficient set by the BASEL
committee =15%

Its simplicity, however, comes at the


price of only limited response to firmspecific needs and characteristics.
While the Basic Indicator Approach
might be suitable for smaller banks with
a simple range of business activities,
the Committee expects internationally
active banks and banks with significant
operational risk to use a more
sophisticated approach within the
overall framework.
Standardized approach:
In the standardized approach a
banks activities are divided into eight
business lines i.e. corporate finance,
trading sales, retail banking, commercial
banking, payment and settlement,
agency service, assets management and
retail brokerage, The capital charge for
each business line is calculated by
multiplying gross income by a factor
(denoted beta) assigned to that
business line(Beta Factor).
Within each business line, the
capital charge is calculated by
multiplying a banks broad financial
indicator by a beta factor. The beta

the management accountant, February, 2009

Cover Feature

factor serves as a rough proxy for the


relationship between the industrys
operational risk loss experience for a
given business line and the broad
financial indicator representing the
banks activity in that business line,
calibrated to a desired supervisory
soundness standard. For example, for
the Retail Brokerage business line, the
regulatory capital charge would be
calculated as follows:
K Retail Brokerage = b Retail Brokerage x (Gross
Income)
Where KRetail Brokerage is the capital
requirement for the retail brokerage
business line, bRetail Brokerage is the capital
factor to be applied to the retail
brokerage business line (each business
line has a different beta factor), and
Gross Income is the indicator for this
business line.
The capital charge for standardized
approach is stated below
KTSA= [ S Years1-3 Max { S (Indicator1-8 X
b1-8 ), 0} ] / 3
Where
KTSA

= The capital charge under


standardized approach.

Indicator1-8 = The indicator is the data


for that business line, i.e.
for Corporate Finance; it
is the gross income for
that business line, not
the whole bank.
b 1-8

= A fixed percentage set by


the committee as stated
earlier.

The total capital charge is calculated


as the three years average of the simple
summation of the regulatory capital
charge for each of the eight-business
line in each year. In any given year the
(ve) capital charge may off-set (+ve)
capital charge in other business lines
without limit. However, if the aggregate
capital charges across all the business
lines within a given year is (ve), then
the m numerator is taken to be zero.

Business
Units
Investment
Banking
Banking

Others

Exhibit-3
Business Line
Indicator
Corporate Finance
Trading and Sales
Retail Banking
Commercial
Banking
Payment and
Settlement
Agency service
Retail Brokerage
Asset Management

Gross Income
Gross Income
Annual Average
Assets
Annual Average
Assets
Annual Settlement
Throughput
Gross Income
Gross Income
Total Funds Under
Management

Beta Factor
18%
18%
12%
15%
18%
15%
12%
12%

Sources:: Consultative Document operational risk, (January 2001), BASEL Committee on


Banking Supervision

Advanced measurement approach:


Under the advanced measurement
approach, capital charge will equal the
risk measurement generated by the risk
measurement system using quantitative
and qualitative approach criteria
suggested by the Banking Committee
for Basel Supervision. Currently,
Advanced Measurement Approach
Banks (AMA Banks) refer to such
banks, which are targeting the advanced
measurement approach in its
implementation of BASEL-II. AMA
banks are facing their operational risk
oriented works in three areas: internal
governance, data issue and modeling/
quantification issue. The BASEL-II
accord provides some key internal
governance issues and corresponding
practices in its management of
operational risk. The mature and quality
of operational risk data collected by an
AMA bank affect both the
quantification process and also the
operational risk management process of
the banks. There are four categories of
the collected data e.g. internal data,
external data, scenario data and data
related to bank business environment
and internal control.
Allowing flexibility in model
development regarding operational risk,
BASEL-II allows continued evolution
and justifies not being prescriptive in
respect of modeling approaches and

the management accountant, February, 2009

assumption. Under AMA, there are two


things to identify to measure
operational risk (a) severity of loss and
(b) frequency of such loss. The severity
can be measured by developing
different model but frequency
determination is really hard to
determine.
Impact of Operational Risk:
Behaviour pattern of operational risk
does not follow the statistical normal
distribution and consequently it
becomes complex to estimate the
probability of an event resulting in
losses. Impact of various forms of
operational risk on the organization
may vary in degree i.e. some risks may
have more potential of causing damages
while some have less, some may occur
more frequently, and some are
occasional. As the impact of operational
risk varies in degree, the measurement
of operational risk becomes a difficult
task. It can be described through the
following matrix
High Impact Low Occurrence:
Example: A plane crash destroying
the main computer site [unlikely to
happen but shall have far reaching
conse-quences]
High Impact High Occurrence:
Example: Unauthorized payments
[Circumstances that need most urgent
dealing with]
109

Cover Feature

Low Impact High Occurrence:


Example: Teller deficiencies. [These
are low impact, individually, but if not
controlled could get out of hand
cumulatively.]
Low Impact Low Occurrence:
This is not to be considered for
controlling operational risk.
Banks require high-quality
operational loss-event information to
enhance their risk modeling and
predictive capabilities. However,
empirical data on operational risk losses
is hard to come by because of numerous
events caused by different techniques
and data availability across banks. In
addition, the variability of operational
risk management process, banking
activities and reporting standard
preclude consistent risk management.
Apart from the dearth of precise
information on operational risk
exposure, this is the toughest task in
comparison to other risk controlling
procedures. The severity of operational
risk can be discussed through exhibit 1.
Since, data of loss arising from
operational risk of Indian bank is not
available we shall consider the data of
certain US banks to understand the

IMPACT

High impact
Low occurrence

High impact
High occurrence

Low impact
High occurrence

Low impact
Low occurrence

OCCURRENCE

impact of operational risk (as shown in

v As the year progresses, the number

exhibit 1)

of participating bank to disclose the


operational risk increases and loss
frequency also increases. It implies
that no bank is behind the vicious
circle of operational risk. It arises
automatically from different areas of
operations of banks.
v The amount of loss is not only
depending upon the number of
occurrences but also on the
quantum of loss in each occurrence.
It may happen that certain nonrecurring events may lead to more
damage to banks as vice versa.

From the above table the following


inferences can be drawn
v The high degree of positive
association between select time
frame with loss frequency and
amount of loss (both total and
average) shows that operational risk
is creeping with the passage of time.
v The above table suggests that the
awareness of bank for disclosing
operational risk is increasing day by
day.

EXHIBIT : 1
AGGREGATE OPERATIONAL RISK LOSSES OF US COMMERCIAL BANK
No of
Year
Year participating
bank

Loss severity
Total loss

Total loss per


bank
(US $ billions)
4=32

Average loss per


bank
(US $ thousands)
5=36

11

(US $ millions)
3

999
1999

0.60

0.10

000
2000

0.40

001
2001

13

002
2002

Loss frequency
(no of loss
events)
All
Per
banks
bank
6

7=62

300

2,000

333

0.06

77

5,167

738

2.40

0.18

313

7,667

590

19

6.12

0.32

448

13,667

719

003
2003

23

12.40

0.54

770

16,100

700

004
2004

20

24.00

1.20

1742

13,777

689

Sources: As reported in 1999-2004 [ODELL(2005)] DE FONTNOUVELLE (2005)The journal for operational risk , volume 2/
number 2; Summer 2007

110

the management accountant, February, 2009

Cover Feature
v We can say that the total loss of a

bank (Y) depends upon three factors


viz. loss incur in last year (X1), loss
frequency(X 2 ) and number of
participating banks(X3). Thus we
can write that Y = f(X1, X2, X3).
However, we have observed that the
strong association between these
dependent variables leads to the
problem of multi-collinerity and for
this reason, we cannot forecast the
loss by drawing any regression
model.
Regulatory Approach to Basel-ii
Implementation in India:
The Reserve Bank of India is the
regulator and supervisor of the banking
system in India and is entrusted with
the task of framing the capital adequacy
guideline for banks in India under BaselII. Reserve Bank of India on 27th April
2007 issued guidelines for
implementation of the New Capital
Adequacy Framework and directed that
foreign banks operating in India and
Indian banks having operational
presence outside India should adopt
Basic Indicator Approach for
operational risk for computing their
capital requirements under the Revised
Framework with effect from 31st March
2008. The guidelines prescribe a series
of disclosures in connection with the
implementation of the new framework.
Disclosures are intended to inform
the general market participants about
the scope of application of new capital
adequacy framework, capital of the
Bank, risk exposures of the Bank, Banks
risk assessment processes, its risk
mitigation strategies and practices and
capital adequacy of the bank.
Problems in the Measurement
Procedure In Indian Context:
We have already observed that a
bank has three options to measure the
operational risk as per BASEL-II
Accord, though there are some
loopholes in each process in the context
of Indian banks.
Basic indicator approach is not at all
suitable for a bank, which is in the range
of higher operational risk. In the Indian
context, almost all nationalized banks

are opting for centralized operational


system, which leads to higher degree
of operational risk.
It has been discussed earlier that
according to standardized approach,
the business line of banks is divided
into eight categories. Although, Indian
banks have started integrating their
activities over the last few years it has
not yet been possible for them to tackle
the entire loss data systematically in
different business lines.
In advanced measurement
approach, due to the allowance of
flexibility, it also raises the possibility
that banks with similar risk profile could
hold different capital charge for
operational risk. In the Indian context,
it is also very difficult to measure the
operational risk only due to the fact that
Indian banks fail to provide sufficient
data resulting in greater operational loss.
It results in biased reporting regarding
risk disclosure of the banks.
Hence, there is a gap regarding the
proper disclosure of operational risk
data in the annual reports of the Indian
Banks and actual estimation of capital
charge for operational risk, which
requires a serious research in this field
of study.
Conclusion:
In the current scenario, it is often
observed that the operational risk
affects the organization severely in
comparison to credit and market risk.
Operational risk also exists in credit as
well as market related activities. Hence,
quantification of operational risk is really
essential. The Meta-model suggested
by Feng Cheng,Nitin Jengtle, Wanli
Min, Bala Ramachandran and David
Gamarnik can be helpful to us. *4
According to this model mitigation
of risk can be done either through
I. Transfer of the risk to another
party(e.g. by insurance) or;
II. Reduction of the impact (e.g. use
more than one provider for key
services) of operational risk;
III. Acceptance of the operational risk
*4

(The journal for operational risk, volume


2/ number 2; Summer 2007)

the management accountant, February, 2009

to manage, control and monitoring


accordingly.
Despite the suggestion given in
BASEL-II, Indian Banks have made a
very limited progress in quantifying
operational risk due to lack of collection
and intention to disclose the operational
loss data. BASEL-II implementation is
really a sensitive issue for the Indian
Banks keeping in view its technical area,
which our banking systems are not aware
of.
To overcome the problems, the
following steps are suggested. Firstly,
it is to be kept in mind that for
controlling operational risk, loss data is
to be captured continuously and
consistently without a time lag of
occurrence. This captured data should
be free from bias. Secondly, historical
data is important only for establishing
parameters to the risk model. For turning
these indicators into useful management
tool like six sigma model, it requires
establishment of standard from past
events, setting goal for future
performance and setting the tolerance
limit beyond which managerial action is
needed. Thirdly, there should be regular
reporting of relevant information to
senior management. It supports
proactive management of operational
risk i.e. to day to day monitoring of
operational risk and material exposure to
measure operational risk properly.
Finally, In a Basel II template, which talks
about how banks should set up a risk
management environment, it actually
mentions that banks should conduct an
internal audit regularly to ensure the
absence of loopholes and noncompliances with policies.
This paper fails to analyse the loss
arising from operational risk of Indian
banks due to lack of information and
henceforth the research can be carried
out in the field of collecting operational
risk data and disclosure of it in annual
reports.
Therefore, it can be concluded that
in this era of globalization, it is high time
for Indian Banks to monitor operational
risk properly in order to compete and
survive amidst internationally active
banks.q
111

Cover Feature
Align strategy and corporate culture

Enterprise Risk
Management (ERM)
Adithya Bhat*
Introduction
n todays challenging global
economy, business opportunities
and risks are constantly changing.
There is a need for identifying,
assessing, managing and monitoring
the
organizations
business
opportunities and risks. The question
is how an organization takes practical
steps to link opportunities and risks
when managing the business, and what
does this have to do with enterprise risk
management?
To be effective, any Enterprise Risk
Management (ERM) implementation
should be integrated with strategysetting. ERM redefines the value
proposition of risk management by
elevating its focus from the tactical
to the strategic. ERM is about
designing and implementing capabilities for managing the risks that matter.
The greater the gaps in the current state
and the desired future state of the
organizations risk management
capabilities, the greater the need for
ERM infrastructure to facilitate the
advancement of risk management
capabilities over time.
Definition of ERM
The Treadway Commissions
Committee of Sponsoring Organizations (COSO) has defined ERM as
a process, effected by an entitys
board of directors, management and
other personnel, applied in strategysetting and across the enterprise,
designed to identify potential events
that may affect the entity, and manage
risk to be within its risk appetite, to

*ACA, Grad CWA, CIA Director Protiviti Consulting Private Limited,


email id: adithya.bhat@protiviti.co.in

112

provide reasonable assurance regarding


the achievement of entity objectives
In a nutshell, ERM is:
A process, ongoing and flowing
through an entity
Effected by people at every level of
an organization
Applied in strategy-setting
Applied across the enterprise, at
every level and unit, and includes
taking an entity-level portfolio view
of risk
Designed to identify potential
events affecting the entity and
manage risk within its risk appetite
Able to provide reasonable
assurance to an entitys
management and board
Geared to the achievement of
objectives in one or more separate
but overlapping categories it is a
means to an end, not an end in itself
ERM is about establishing the
oversight, control and discipline to
drive continuous improvement of an
entitys risk management capabilities in
a changing operating environment. It
advances the maturity of the
enterprises capabilities around
managing its priority risks.
Why Implement ERM?
ERM needs to be implemented for
the following reasons:
Reduce unacceptable performance
variability
Align and integrate varying views
of risk management
Build confidence of investment
community and stakeholders
Enhance corporate governance
Successfully respond to a changing
business environment

Scope of ERM vis--vis existing Risk


Management Process
Traditional risk management
approaches are focused on protecting
the tangible assets reported on a
companys balance sheet and the
related contractual rights and
obligations. The emphasis of ERM,
however, is on enhancing business
strategy. The scope and application of
ERM is much broader than protecting
physical and financial assets. With an
ERM approach, the scope of risk
management is enterprise-wide and the
application of risk management is
targeted to enhancing as well as
protecting the unique combination of
tangible and intangible assets
comprising the organizations business
model.
With market capitalization often
significantly exceeding historical
balance sheet values, the application of
risk management to intangible assets is
critically important. Just as potential
future events can affect the value of
physical and financial assets, so, too,
can they affect the value of key
intangible assets, e.g., customer assets,
employee/ supplier assets and
organizational assets such as the
entitys
distinctive
brands,
differentiating strategies, innovative
processes and proprietary systems.
This is the essence of what ERM
contributes to the organization the
elevation of risk management to a
strategic level by broadening its
application to ALL sources of value,
not just physical and financial ones.
The five broad categories of assets
representing sources of value, and
examples within each category, are
illustrated aside1.
1

Cracking the Value Code: See What Matters,


Invest in What Matters and Manage What
Matters in the New Economy, Richard E.S.
Boulton, Barry D. Liebert and Steve M.
Samek, Harper Collins, 2000.

the management accountant, February, 2009

Cover Feature

These five categories include


sources of value underlying an
organizations business strategy. By
placing the emphasis on strategysetting, ERM transitions risk
management from a discipline of
avoiding and hedging bets to a
differentiating skill for enhancing and
protecting enterprise value as
management seeks to make the nest bets
in the pursuit of new opportunities for
growth and returns. ERM invigorates
opportunity-seeking behavior by
helping managers become confident in
their understanding of the risks and in
the capabilities at hand within the
organization to manage those risks.
The risk assessment process can
lead to more comprehensive risk
responses when management identifies
potential future events that could affect
each category of assets critical to the
execution of the enterprises business

model. The schematic below illustrates


categories of potential future events that
might be considered during a risk
assessment:
An enterprises sources of value,
inherent in its business model, are
affected by sources of uncertainty,

the management accountant, February, 2009

external or internal, which an enterprise


must understand and manage. However,
fundamentally risk is about knowledge.
When Management lacks knowledge, there is greater risk. Thus an
important source of risks relates to the
relevance, timeliness and reliability of

113

Cover Feature

information about the external and


internal environment. The three broad
categories provide the basis for
understanding the sources of uncertainty
in any business. These risk categories
include many sub categories of potential
future events which could become the
focal point for assessing risk and
formulating appropriate risk responses.

Value Proposition
Directors and CEOs face many
challenges. They must focus their
organizations to capitalize on emerging
opportunities. They must continually
invest scarce resources in the pursuit
of promising though uncertain
business activities. They must manage
the business in the face of constantly
changing circumstances. And as they
do all of these things, they must
simultaneously be in a position to
provide assurance to investors,
directors and other stakeholders that
their organizations know how to protect
and enhance enterprise value. Amid
constantly changing risk profiles,
directors and CEOs need a higher level
of performance from every discipline
within the organization, including risk
management.
These value added contributions

from ERM lead to possibly the greatest


single benefit risk management provides
for the success of a business - Instills
greater confidence in the board, CEO
and executive management. These
stakeholders need to know that risks
and opportunities are systematically
identified, rigorously analyzed and costeffectively managed on an enterprisewide basis, in a manner consistent with
the enterprises risk appetite and
business model for creating value.
Under ERM, Management are more
knowledgeable of the risk inherent in
their operations and also understand
the process by which risks are
identified, assigned ownership in a
timely fashion and ensuring that risk

responses are formulated timely and


monitored effectively.
To Conclude
An effectively functioning ERM
infrastructure can become one of the
root differentiators between mere
survivors and industry pacesetters.
Beyond delivering the above benefits,
redefining the value proposition of risk
management will add to the CEOs story
line with stakeholders in todays
demanding environment. An ERM
approach helps an organization to build
its image and reputation with customers,
suppliers, employees and the capital
markets, all of which are keys to sustaining
a successful business enterprise.q

NOTIFICATION

National Institute of Securities Markets (NISM) is organising a series of executive


education programme for auditors of broking firms at Mumbai, Delhi, Kolkata and
Chennai. There are six such programmes in Mumbai and two each in Delhi, Kolkata
and Chennai. The programme are targeted at Chartered Accountants, Company
Secretaries and ICWAs to highlight the expectations from Audit reports of broking
firms in compliance of regulatory requirements.
The Programme in Delhi is on Feb 20-21st 2009 and April 24th-25th 2009 at India
Habitat Centre and India International Centre respectively. Other details are also available
on websites www.icwai.org and www.nismindia.com.
114

the management accountant, February, 2009

Accounting Issues

IAS 17 : Leases
A Closer Look
K.S.Muthupandian*

nternational Accounting Standard


(IAS) 17, Leases, prescribes the
accounting treatment for Leases. In
October 1980, the International
Accounting Standards Committee
(IASC) issued the Exposure Draft E19,
Accounting for Leases. In September
1982, the IASC issued IAS 17,
Accounting for Leases, effective from
January 1, 1984. In 1994, the IASC
reformatted the IAS 17 (1982). In April
1997, the IASC issued Exposure Draft
E56, Leases. The IASC issued revised
IAS 17, Leases, in December 1997. The
effective date of IAS 17 (1997) was fixed
as January 1, 1999. On December 18,
2003, the International Accounting
Standards Board (IASB), as part of an
improvement project, issued the revised
version of IAS 17, which supersedes
IAS 17 (1997). The revised IAS 17 (2003),
Leases, became effective for financial
statements covering periods beginning
on or after January 1, 2005.
Objective
The objective of IAS 17 is to
prescribe, for lessees and lessors, the
appropriate accounting treatment and
disclosures to apply in relation to
leases.
Scope and Application
IAS 17 applies to accounting for all
leases other than:
(a) leases to explore for or use minerals,
oil, natural gas and similar nonregenerative resources; and

*M.Com., AICWA 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

(b) licensing agreements for such items


as motion picture films, video
recordings, plays, manuscripts,
patents and copyrights.
However, IAS 17 shall not be applied
as the basis of measurement for the
following leased assets:
(a) property held by lessees, that is
accounted for as investment
property (IAS 40, Investment
property);
(b) investment property provided by
lessors under operating leases (IAS
40);
(c) biological assets held by lessees
under finance leases (IAS 41,
Agriculture); or
(d) biological assets provided by
lessors under operating leases (IAS
41).
IAS 17 applies to agreements that
transfer the right to use assets even
though substantial services by the
lessor may be called for in connection
with the operation or maintenance of
such assets. IAS 17 does not apply to
agreements that are contracts for
services that do not transfer the right
to use assets from one contracting party
to the other.
Classification of Leases
The classification of leases adopted
in IAS 17 is based on the extent to which
risks and rewards incidental to
ownership of a leased asset lie with the
lessor or the lessee. Risks include the
possibilities of losses from idle capacity
or technological obsolescence and of
variations in return because of changing
economic conditions. Rewards may be
represented by the expectation of
profitable operation over the assets

the management accountant, February, 2009

economic life and of gain from


appreciation in value or realisation of a
residual value.
A lease is classified as a finance
lease if it transfers substantially all the
risks and rewards incidental to
ownership. A lease is classified as an
operating lease if it does not transfer
substantially all the risks and rewards
incidental to ownership. Classification
is made at the inception of the lease.
Whether a lease is a finance lease
or an operating lease depends on the
substance of the transaction rather than
the form of the contract.
Examples of situations that
individually or in combination would
normally lead to a lease being classified
as a finance lease are:
(a) the lease transfers ownership of the
asset to the lessee by the end of the
lease term;
(b) the lessee has the option to
purchase the asset at a price that is
expected to be sufficiently lower
than the fair value at the date the
option becomes exercisable for it to
be reasonably certain, at the
inception of the lease, that the
option will be exercised;
(c) the lease term is for the major part of
the economic life of the asset even
if title is not transferred;
(d) at the inception of the lease the
present value of the minimum lease
payments amounts to at least
substantially all of the fair value of
the leased asset; and
(e) the leased assets are of such a
specialised nature that only the
lessee can use them without major
modifications being made.
Indicators of situations that
individually or in combination could
also lead to a lease being classified as a
finance lease are:
(a) if the lessee can cancel the lease,
the lessors losses associated with
the cancellation are borne by the
lessee;
115

Accounting Issues

(b) gains or losses from the fluctuation


in the fair value of the residual accrue
to the lessee (for example, in the form
of a rent rebate equalling most of
the sales proceeds at the end of the
lease); and
(c) the lessee has the ability to continue
the lease for a secondary period at a
rent that is substantially lower than
market rent.
In classifying a lease of land and
buildings, land and buildings elements
would normally be separately. The
minimum lease payments are allocated
between the land and buildings
elements in proportion to their relative
fair values. The land element is normally
classified as an operating lease unless
title passes to the lessee at the end of
the lease term. The buildings element is
classified as an operating or finance
lease by applying the classification
criteria in IAS 17. However, separate
measurement of the land and buildings
elements is not required if the lessees
interest in both land and buildings is
classified as an investment property in
accordance with IAS 40 and the fair
value model is adopted.
Key Definitions
A lease is an agreement whereby the
lessor conveys to the lessee in return
for a payment or series of payments the
right to use an asset for an agreed period
of time.
A finance lease is a lease that
transfers substantially all the risks and
rewards incidental to ownership of an
asset. Title may or may not eventually
be transferred.
An operating lease is a lease other
than a finance lease.
A non-cancellable lease is a lease
that is cancellable only:
(a) upon the occurrence of some remote
contingency;
(b) with the permission of the lessor;
(c) if the lessee enters into a new lease
for the same or an equivalent asset
with the same lessor; or
116

(d) upon payment by the lessee of such


an additional amount that, at
inception of the lease, continuation
of the lease is reasonably certain.
The inception of the lease is the
earlier of the date of the lease agreement
and the date of commitment by the
parties to the principal provisions of the
lease. As at this date:
(a) a lease is classified as either an
operating or a finance lease; and
(b) in the case of a finance lease, the
amounts to be recognised at the
commencement of the lease term are
determined.
The commencement of the lease
term is the date from which the lessee
is entitled to exercise its right to use the
leased asset. It is the date of initial
recognition of the lease (i.e. the
recognition of the assets, liabilities,
income or expenses resulting from the
lease, as appropriate).
The lease term is the noncancellable period for which the lessee
has contracted to lease the asset
together with any further terms for
which the lessee has the option to
continue to lease the asset, with or
without further payment, when at the
inception of the lease it is reasonably
certain that the lessee will exercise the
option.
Minimum lease payments are the
payments over the lease term that the
lessee is or can be required to make,
excluding contingent rent, costs for
services and taxes to be paid by and
reimbursed to the lessor, together with:
(a) for a lessee, any amounts
guaranteed by the lessee or by a
party related to the lessee; or
(b) for a lessor, any residual value
guaranteed to the lessor by:
(i) the lessee;
(ii) a party related to the lessee; or
(iii) a third party unrelated to the lessor
that is financially capable of

discharging the obligations under


the guarantee.
However, if the lessee has an option
to purchase the asset at a price that is
expected to be sufficiently lower than
fair value at the date the option becomes
exercisable for it to be reasonably
certain, at the inception of the lease, that
the option will be exercised, the
minimum lease payments comprise the
minimum payments payable over the
lease term to the expected date of
exercise of this purchase option and the
payment required to exercise it.
Fair value is the amount for which
an asset could be exchanged, or a
liability
settled,
between
knowledgeable, willing parties in an
arms length transaction.
Economic life is either:
(a) the period over which an asset is
expected to be economically usable
by one or more users; or
(b) the number of production or similar
units expected to be obtained from
the asset by one or more users.
Useful life is the estimated
remaining period, from the
commencement of the lease term,
without limitation by the lease term, over
which the economic benefits embodied
in the asset are expected to be
consumed by the entity.
Guaranteed residual value is:
(a) for a lessee, that part of the residual
value that is guaranteed by the
lessee or by a party related to the
lessee (the amount of the guarantee
being the maximum amount that
could, in any event, become
payable); and
(b) for a lessor, that part of the residual
value that is guaranteed by the
lessee or by a third party unrelated
to the lessor that is financially
capable of discharging the
obligations under the guarantee.
Unguaranteed residual value is that

the management accountant, February, 2009

Accounting Issues

portion of the residual value of the


leased asset, the realisation of which
by the lessor is not assured or is
guaranteed solely by a party related to
the lessor.

amount of a factor that changes other


than with the passage of time (e.g.
percentage of future sales, amount of
future use, future price indices, future
market rates of interest).

Initial direct costs are incremental


costs that are directly attributable to
negotiating and arranging a lease,
except for such costs incurred by
manufacturer or dealer lessors.

Measurement in the financial


statements of Lessees

Gross investment in the lease is the


aggregate of:
(a) the minimum lease payments
receivable by the lessor under a
finance lease; and
(b) any unguaranteed residual value
accruing to the lessor.
Net investment in the lease is the
gross investment in the lease
discounted at the interest rate implicit
in the lease.
Unearned finance income is the
difference between:
(a) the gross investment in the lease;
and
(b) the net investment in the lease.
The interest rate implicit in the
lease is the discount rate that, at the
inception of the lease, causes the
aggregate present value of:
(a) the minimum lease payments and
(b) the unguaranteed residual value to
be equal to the sum of:
(i) the fair value of the leased asset and
(ii) any initial direct costs of the lessor.
The lessees incremental
borrowing rate of interest is the rate of
interest the lessee would have to pay
on a similar lease or, if that is not
determinable, the rate that, at the
inception of the lease, the lessee would
incur to borrow over a similar term, and
with a similar security, the funds
necessary to purchase the asset.
Contingent rent is that portion of
the lease payments that is not fixed in
amount but is based on the future

Financial leases - Initial recognition


l At the commencement of the lease

term, finance leases are recognised


as assets and liabilities at amounts
equal to the fair value of the leased
property or, if lower, the present
value of the minimum lease
payments each determined at the
inception of the lease.
l The discount rate to be used in

calculating the present value of the


minimum lease payments is the
interest rate implicit in the lease, if
this is practicable to determine; if
not, the lessees incremental
borrowing rate is used.
l Any initial direct costs of the lessee

are added to the amount recognised


as an asset.
Financial leases - Subsequent
measurement
l Minimum lease payments are

apportioned between the finance


charge and the reduction of the
outstanding liability.
l The finance charge is allocated to

each period during the lease term


so as to produce a constant periodic
rate of interest on the remaining
balance of the liability.
l Contingent rents are charged as

expenses in the periods in which


they are incurred.
l The depreciation policy for

depreciable leased assets is to be


consistent with that for depreciable
assets that are owned, and the
depreciation recognised shall be
calculated in accordance with IAS
16, Property, Plant and Equipment
and IAS 38, Intangible Assets.

the management accountant, February, 2009

l If there is no reasonable certainty

that the lessee will obtain ownership


by the end of the lease term, the
asset should be fully depreciated
over the shorter of the lease term
and its useful life.
Operating leases - Recognition
l Lease payments are recognised as
an expense on a straight-line basis
over the lease term unless another
systematic basis is more
representative of the time pattern of
the users benefit.
Measurement in the financial
statements of Lessors
Financial leases - Initial recognition
l Assets held under a finance lease
are presented as a receivable at an
amount equal to the net investment
in the lease.
Financial leases - Subsequent
measurement
l Finance income shall be based on a
pattern reflecting a constant
periodic rate of return on the lessors
net investment in the finance lease.
l Manufacturer or dealer lessors
recognise selling profit or loss in the
period, in accordance with the policy
followed by the entity for outright
sales. If artificially low rates of
interest are quoted, selling profit
shall be restricted to that which
would apply if a market rate of
interest were charged. Costs
incurred by manufacturer or dealer
lessors in connection with
negotiating and arranging a lease
shall be recognised as an expense
when the selling profit is recognized.
l An asset under a finance lease that
is classified as held for sale (or
included in a disposal group that is
classified as held for sale) in
accordance with International
Financial Reporting Standard (IFRS)
5, Non-Current Assets Held For
Sale And Discontinued Operations
shall be accounted for in accordance
with that IFRS.
117

Accounting Issues

Operating leases - Recognition


l Assets subject to operating leases

are presented in the balance sheet


according to the nature of the asset.
l Lease income from operating leases
is recognised on a straight-line basis
over the lease term, unless another
systematic basis is more
representative of the time pattern in
which use benefit derived from the
leased asset is diminished.
l Initial direct costs incurred by

lessors in negotiating and arranging


an operating lease shall be added to
the carrying amount of the leased
assert and recognised as an expense
over the lease term on the same basis
as the lease income.
l The depreciation policy for

depreciable leased assets shall be


consistent with the lessors normal
depreciation policy for similar
assets, and depreciation shall be
calculated in accordance with IAS
16 and IAS 38.
Prescribed Disclosures
Lessees - Finance Lease
Lessees shall, in addition to meeting
the requirements of IFRS 7, Financial
instruments: Disclosures make the
following disclosures for finance leases:
(a) for each class of asset, the net
carrying amount at the balance sheet
date;

(c) contingent rents recognised as an


expense in the period;
(d) the total of future minimum sublease
payments expected to be received
under non-cancellable subleases at
the balance sheet date;
(e) a general description of the lessees
material leasing arrangements,
including, but not limited to, the
following:
(i) the basis on which contingent rent
payable is determined;
(ii) the existence and terms of renewal
or purchase options and escalation
clauses; and
(iii) restrictions imposed by lease
arrangements, such as those
concerning dividends, additional
debt, and further leasing.
Lessees - Operating Lease
Lessees shall, in addition to meeting
the requirements of IFRS 7, make the
following disclosures for operating
leases:
(a) the total of future minimum lease
payments under non-cancellable
operating leases for each of the
following periods:
(i) not later than one year (next year);
(ii) later than one year and not later than
five years (years 2 through 5
combined);
(iii) later than five years;

(b) a reconciliation between the total of


future minimum lease payments at
the balance sheet date, and their
present value. In addition, an entity
shall disclose the total of future
minimum lease payments at the
balance sheet date, and their
present value, for each of the
following periods:
(i) not later than one year (next year);

(c) lease and sublease payments


recognised as an expense in the
period, with separate amounts for
minimum lease payments,
contingent rents, and sublease
payments;

(ii) later than one year and not later than


five years (years 2 through 5
combined);
(iii) later than five years;

(d) a general description of the lessees


significant leasing arrangements,
including, but not limited to, the
following:

118

(b)the total of future minimum sublease


payments expected to be received
under non-cancellable subleases at
the balance sheet date;

(i) the basis on which contingent rent


payable is determined;
(ii) the existence and terms of renewal
or purchase options and escalation
clauses; and
(iii) restrictions imposed by lease
arrangements, such as those
concerning dividends, additional
debt and further leasing.
Lessors - Finance Lease
Lessors shall, in addition to meeting
the requirements in IFRS 7, disclose the
following for finance leases:
(a) a reconciliation between the gross
investment in the lease at the balance
sheet date, and the present value of
minimum lease payments receivable
at the balance sheet date. In
addition, an entity shall disclose the
gross investment in the lease and
the present value of minimum lease
payments receivable at the balance
sheet date, for each of the following
periods:
(i) not later than one year (next year);
(ii) later than one year and not later than
five years (years 2 through 5
combined);
(iii) later than five years;
(b) unearned finance income;
(c) the unguaranteed residual values
accruing to the benefit of the lessor;
(d) the accumulated allowance for
uncollectible minimum lease
payments receivable;
(e) contingent rents recognised as
income in the period;
(f) a general description of the lessors
material leasing arrangements.
Lessors - Operating Lease
Lessors shall, in addition to meeting
the requirements of IFRS 7, disclose the
following for operating leases:
(a) the future minimum lease payments
under non-cancellable operating
leases in the aggregate and for each
of the following periods:
(i) not later than one year (next year);

the management accountant, February, 2009

Accounting Issues

(ii) later than one year and not later than


five years (years 2 through 5
combined);
(iii) later than five years;
(b) total contingent rents recognised as
income in the period;
(c) a general description of the lessors
leasing arrangements.
Sale and Leaseback Transactions
A sale and leaseback transaction
involves the sale of an asset and the
leasing back of the same asset. The lease
payment and the sale price are usually
interdependent because they are
negotiated as a package.
The accounting treatment of a sale
and leaseback transaction by a sellerlessee depends upon the type of lease
involved:
l For a sale and leaseback transaction
that results in a finance lease, any
excess of sales proceeds over the
carrying amount is deferred and
amortised over the lease term.
l For a sale and leaseback transaction
that results in an operating lease:
l if the transaction is clearly carried
out at fair value - the profit or loss
should be recognised immediately;
l if the sale price is below fair value -

profit or loss should be recognised


immediately, except if a loss is
compensated for by future lease
payments at below market price, the
loss it should be amortised over the
period of use;
l if the sale price is above fair value -

the excess over fair value should be


deferred and amortised over the
period of use; and
l if the fair value at the time of the

transaction is less than the carrying


amount - a loss equal to the
difference between the carrying
amount and the fair value should be
recognised immediately.
SIC Interpretations
The

International

Financial

Reporting Interpretations Committee


(IFRIC) and the Standing Interpretation
Committee (SIC) of the IASB has issued
the following four Interpretations
relating to IAS 17:
l IFRIC 4, Determining whether an
Agreement contains a Lease
l IFRIC 12, Service Concession
Arrangements
l SIC 15, Operating Leases Incentives
l SIC 27, Evaluating the Substance
of Transactions in the Legal Form
of a Lease
In December 2004, the IASB issued
IFRIC 4. This interpretation explains that
the requirements of IAS 17 have wider
applicability than just those agreements
described as leases.
On November 30, 2006, the IASB
issued IFRIC 12 with the objective to
clarify how certain aspects of existing
IASB literature are to be applied to
service concession arrangements.
Service concessions are arrangements
whereby a government or other public
sector entity grants contracts for the
supply of public servicessuch as
roads, bridges, tunnels, airports, prisons
and energy and water supply and
distribution facilitiesto private sector
operators. Control of the assets remains
in public hands but the private sector
operator is responsible for construction
activities, as well as for operating and
maintaining the public sector
infrastructure. IFRIC 12 addresses how
service concession operators should
apply existing IFRSs to account for the
obligations they undertake and rights
they receive in service concession
arrangements.
SIC 15 was issued in July 1999 and
it clarifies the recognition of incentives
related to operating leases by both the
lessee and lessor. The interpretation
indicates that lease incentives (such as
rent-free periods or contributions by the
lessor to the lessees relocation) should
be considered an integral part of the

the management accountant, February, 2009

consideration for the use of the leased


asset.
SIC 27 was issued in December 2001
and addresses issues that may arise
when an arrangement between an
enterprise and an investor involves the
legal form of a lease. The provisions of
SIC 27 include:
Accounting for arrangements
between an enterprise and an investor
should reflect the substance of the
arrangement. All aspects of the
arrangement should be evaluated to
determine its substance, with weight
given to those aspects and implications
that have an economic effect. In this
respect, SIC 27 includes a list of
indicators that individually demonstrate
that an arrangement may not, in
substance, involve a lease under IAS
17.
If an arrangement does not meet the
definition of a lease, SIC 27 addresses
whether a separate investment account
and lease payment obligation that might
exist represent assets and liabilities of
the enterprise; how the enterprise
should account for other obligations
resulting from the arrangement; and
how the enterprise should account for
a fee it might receive from an Investor.
SIC 27 includes a list of indicators that
collectively demonstrate that, in
substance, a separate investment
account and lease payment obligations
do not meet the definitions of an asset
and a liability and should not be
recognised by the enterprise.
A series of transactions that involve
the legal form of a lease is linked, and
therefore should be accounted for as
one transaction, when the overall
economic effect cannot be understood
without reference to the series of
transactions as a whole.
IASB-FASB Joint Project on Lease
Accounting
In February 2006, the IASB and the
United States Financial Accounting
Standards Board (FASB) issued a
119

Accounting Issues

Memorandum of Understanding (MoU)


that described a joint work plan to
expedite global convergence in
accounting standards and that
established a series of milestones to be
reached by 2008. The leases project is
part of the 2006 MoU. Under the 2006
MoU, the IASB and the FASB agreed
to consider and make a decision about
the scope and timing of a potential
leasing project by 2008. This goal was
achieved when the IASB and the FASB
added the leasing project to their
respective agendas on July 19, 2006.
FASB Statement No. 13 (FAS 13),
Accounting for Leases, issued in 1976,
provides guidance on accounting for
leases for both lessors and lessees.
According to the provisions of FAS 13,
a lessee should recognize both an asset
and a liability for a lease that transfers
substantially all benefits and risks
incident to the ownership of property,
and a lessor should recognize such a
lease as a sale or financing. Under FAS
13, a lease that does not transfer
substantially all benefits and risks
incident to the ownership of property
is classified as an operating lease by
the lessee. Under operating lease
classification, the lessee does not
recognize any elements of the lease on
its balance sheet (that is, it does not
recognize an asset for the right to use
the leased item or a related liability for
the future lease payments); rather, the
lessee recognizes rental expense as it
becomes payable.
IAS 17 was very similar to FAS 13
as it was based on the extent to which
risks and rewards incident to ownership
of a leased asset lie with the lessor or
the lessee. Although IAS 17 has been
amended several times, its most recent
version retains the fundamental
approach to the accounting for leases
contained in the original standard.
Leasing is a major international
industry, and a very important source
of finance for a wide range of entities.
Consequently, the IASB believes that
120

it is important to seek the views of both


users and preparers of financial
statements as the project progresses.
The IASB and FASB have therefore
established a joint working group for
this project. On December 8, 2006, the
IASB and the FASB announced the
membership of a new international
working group that will help the boards
in their joint project on lease
accounting. The FASB and the IASB
announced the joint project, to
comprehensively reconsider the
guidance in FAS 13, Accounting for
Leases and IAS 17, Leasesto ensure
that investors and other users of
financial statements are provided
useful, transparent and complete
information about leases. The joint
project involves comprehensive
reconsideration of all aspects of lease
accounting and is expected to lead to a
fundamental changes in how lessees
and lessors account for leases.
The Boards updated the 2006 MoU
at the April 2008 joint meeting. As part
of the updated MoU, the leases
projects estimated completion date is
2011.
The draft Discussion Paper (DP)
which has not been approved by the
FASB or the IASB would express a
preliminary view of the two Boards in
favour of replacing the current lease
accounting model with a new model.
The current model classifies leases
as finance leases or operating leases,
with the former accounted for as, in
substance, financed purchases of the
leased asset. Under the proposed new
model, a lessee would recognise as
assets and liabilities all material rights
and obligations arising in all lease
contracts, including those rights and
obligations that arise under leases
currently classified as operating leases.
Thus, a lessee would recognise:
l an asset representing its right to use
the leased item for the lease term,
and

l a liability for its obligation to pay

rentals.
The operating and finance lease
classifications would be eliminated.
In January 2009, the FASB has made
the decision that lessor accounting
(including subleases) should be further
analysed and included as a high level
discussion in the DP with specific
questions, but without changing the
scope of the DP. The FASB has also
discussed whether in-substance
purchases should be within the scope
of the project, but decided no change
in scope. Furthermore, FASB discussed
how a right-of-use model as proposed
for lessees in the DP could be applied
to lessor and decided that its DP should
have a high-level discussion of lessor
accounting. In this situation, the IASB
decided to issue the IASB DP in the
first quarter of 2009 and publish any
output from the FASB as a
supplementary DP.
Following publication of the DP, the
Boards will move towards publication
of an exposure draft on lease
accounting. This exposure draft will
take into account comments received
from constituents on the DP. The staff
of the Boards expects a final standard
on lease accounting to be published in
the second quarter of 2011.
Comparative Indian Standard
The Accounting Standard issued
by the Institute of Chartered
Accountants of India (ICAI)
comparative to IAS 17 is AS 19, Leases.
AS 19 is based on the earlier IAS 17
(1997). IAS 17 has been revised in 2004.
The major differences between IAS 17
and AS 19 are conceptual differences
and described hereinafter:
1. Keeping in view the peculiar land
lease practices in the country, lease
agreements to use lands are
specifically excluded from the scope
of AS 19 whereas IAS 17 does not
contain this exclusion.
Contd. on Page 122

the management accountant, February, 2009

Outsourcing

Outsourcing an opportunity
P. Subramanian*

he global economic recession


and consequent business risks
have created a business
opportunity for the Outsourcing
industry. Industrial captains are
compelled to explore options at down
sizing and reduction in operational
costs to the company. Outsourcing is
an emerging business option to the top
management of the company.
Identification of signals or business
indicators which compel the stake
holder to think about outsourcing some
of his business sub processes is vital
to the firm . Let us examine a few of
such business indicators which prompt
thoughts/ideas on outsourcing.
a) Economic downturns or melt downs
- these are situations when there is
a sudden shortage in liquidity of
funds required in business. This
causes disturbance to the business
process and stake holders are
compelled to review cash flows of
the firm.
b) Bearish phase in global stock
markets - in this situation the market
valuation of business takes the
impact and the credit rating agencies
tend to downgrade the business
prospects of the firm. This is an
important trigger to ideate about
outsourcing.
This can also be
motivated by business competitors
and impacts the on going business
of the firm; besides, eroding the
share holders faith in the firm.
c) Sudden imbalance in the tax
structures of the government - at
times, the imposition of new levies
aimed at protecting the domestic
industry or promoting global
business also adversely impacts the
on going business of the firm. This
causes an imbalance in the market
demand supply for the key products
of the firm.

d) Top Management exit from business


- at times, the CEO or Key personnel
in a firm separate from the
organization causing a void in the
firm. This causes an alarm and few
more competent employess of the
firm also leave with the leader or key
resource. Such a situation is quicky
addressed by outsourcing few of
the functions and honour the
delivery commitments to customers.
Identification of the first business
sub process to be chosen for
outsourcing is best guided by costs
incurred . The costs in a manufacturing
company is as follows :
The sub process which is likely to
provide impetus to the outsourcing
process is to be chosen first , the risks
identified and a risk management plan
should be in place. The scope of the
outsourced process could be either in
full or in part or light support basis
depending on the estimated benefits &
related risks to the current operations
of the business. A cross functional team

*CEO & Director, E-Star Exchange Pvt. Ltd.

the management accountant, February, 2009

is best equipped to define the scope of


support to be provided in the outsoured
process.
The salient sub processes in the
outsourcing of any process in an
industry consists of :1. Preparation of RFP document
2. Assessment of baseline services
3. Assessment of baseline cost
4. Define the rules
5. Draft contract terms
6. Prepare Negotiation strategy
7. Resource requirement
8. Prepare Contract Score Card
9. Draft the Service Level Agreement
10. Financial KPIs
11. Relationship metrics
12. Strategic metrics
13. Dashboard for information
The first cycle in the outsourcing
arrangement is a fertile area for learning
for both the parties to the contract; the
Client and the Service Provider. This
can be leveraged while considerting the
outsourcing for the next cycle .
Performance Analytics during the
first cycle can be done as

Cost in Manufacturing

15%
7%
3%
55%
11%
9%

Material costs
Manpower Cost
Contract Cost

Conversion cost
Overheads cost
Interest & Finance cost
121

Outsourcing
l
l
l
l
l

Gap Analysis
Stake Holder Satisfaction
Performance & Cost trends
SWOT Analysis
Degree to which outsourcing goals
were achieved
l Benchmarking performances
l Updated knowledge on technology
applications
l Information on new service
providers who have evolved since
last agreement.
Based on the above inputs and new
requirements , if any, the scope of the
outsourcing can be revised so that the
outsourcing goals can be achieved.
For the next cycle options are
available :
1. Retaining the same outsourcing
agency
2. Re-Tendering
3. Back office outsourcing

The next generation offers the


opportunity to determine new
requirements and to refresh original
ones, especially if this has not been a
continuing process.
1. Forecast business requirements of
and potential changes in the
projected life of any new
outsourcing arrangement.
2. Reconsider the scope and potential
bundling/unbundling of services.
3. Develop revised service level
agreements, contracts and price
models in addition to the contract
management function and the
retained organization. Otherwise
you risk having to deal with underscoped bids, service providers
lacking the necessary expertise, and
potentially very expensive
remedies.
There could be five capability areas
to describe an improvement path that

clients should expect service providers


to travel :
1. Providing services
2. Consistently meeting requirements
3. Managing organizational performance
4. Proactively enhancing value
5. Sustaining excellence.
The process of quality certification
envisages a role for the lead QA
consultants, Lead Auditors & Certifying
institutions/organizations. Such
system shall result in objective
differentiation of quality services
rendered by the empanelled Service
Providers and provide a reliable platform
for inter service provider comparison of
capability & competency skills.
Therefore, in todays business
environment outsourcing is emerging
as the most effective business tool in
achieving cost reduction, operational
& financial excellence in Business.

4. As per IAS 17 initial direct costs


incurred by a lessor other than a
manufacturer or dealer lessor have
to be included in amount of lease
receivable in the case of finance
lease resulting in reduced amount
of income to be recognised over
lease term and in the carrying amount
of the asset in the case of operating
lease as to expense it over the lease
term on the same basis as the lease
income. However, as per AS 19,
these can be either charged off at
the time of incurrence in the
statement of profit and loss or can
be amortised over the lease period.
Conclusion
Leasing is a global business, and
differences in accounting standards can
lead to considerable non-comparability.

The primary objective of the leases


project is to develop a new model for
the recognition of assets and liabilities
arising under lease contracts to ensure
that financial statements provide useful,
transparent, and complete information
about leasing transactions to investors
and other users of financial statements.
The IASB-FASB joint project is likely
to lead to a new accounting standard
that will abolish the distinction between
operating and finance leases and
require all companies to show the asset
and liability created by a lease on the
balance sheet as is currently required
only for finance leases, so even if
unlisted companies do not presently
have to comply with IAS 17, the writing
is on the wall.q

Contd. from Page 120


2. IAS 17 specifically provides that the
Standard shall not be applied as the
basis of measurement for:
(a) property held by lessees that is
accounted for as investment
property;
(b) investment property provided by
lessors under operating leases;
(c) biological assets held by lessees
under finance leases; or
(d) biological assets provided by
lessors under operating leases.
However, AS 19 does not exclude
the above from its scope.
3. AS 19 specifically prohibits upward
revision
in
estimate
of
unguaranteed residual value during
the lease term. However IAS 17
does not prohibit the same.

RETIREMENT
Shri Dilip Kumar Choudhuri, Senior Assistant cum Computer Operator has retired
from the Institutes business on January 31, 2009. We at ICWAI place on record his
long and distinguished services to the Institute and wish him a very happy, fruitful and
healthy life ahead.
122

the management accountant, February, 2009

Emerging Issues

Employee Governance
R.Soundara Rajan*
Chitra Rajan**

any organization and


individuals feel that
corporate governance is
regulated through the laws such as
Companies Act 1956 or clause 4-9 of
listing agreement. The management
feels that their responsibility ends in
complying and sending timely reports
to regulators. The stage has been set to
review the disclosures to the
shareholders and the way the
employees are governed. Governance
should not aim only to take care of
shareholders. Old theory of capital
fetches the labor has to be re-looked.
Labor is an essential ingredient for the
organization survival. If the necessary
skill set and energi/.ed employees are
not available, any amount of capital may
not help the organization sustainability
in the competitive environment. A
coalition approach of shareholders and
employees is to be followed in the
corporate governance process. This
paper highlights the present scenario
and the improvement needed including
the disclosures required.
Corporate governance over view
Corporate governance is ... holding the
balance between economic and social
goats and between individual and
community goals. The governance
framework is (here to encourage the
etlicient use of resources and equally to
require accountability for the
stewardship of those resources. The aim
is to align as nearly as possible the
interests of individuals, corporations
*BE(Hons), AICWA, ACS, MBA, MPhil
is presently working as a company
secretary at Engineers India Limited.
**MA(Econ), MA (English), MA
(History), M Ed is an economist and a
freelance writer.

and society. The incentive to


corporations is to achieve their
corporate aims and to attract
investment. The incentive for states is
to strengthen their economics and
discourage fraud and mismanagement.
(Sir Adrian Cadbury from the preface
to the World Bank Publication,
Corporate Governance: A Framework
for Implementation)

Corporate governance is defined as


a set of process, customs, policies,
laws and institutions affecting the way
a corporation is directed, administered
or controlled. Further it also indicates
the relationships among the many
players involved (stake holders) and
the goals for which the corporation is
governed.
The above definition highlights the
relationship between players and Stake
Holders. The players are Share Holders,
management and the board of directors.
The Stake Holders include the
employees, customers, suppliers, banks
and other lenders, regulators, the
environment and the community at
large.
Corporate governance is a multifaceted subject. Management view the
governance as the processes by which
companies are directed and controlled
where as a field in economics, views as
the issues arising from separation of
ownership and control.
Ownership and Stake Holder theory:
If capital and labor were1 similar input
then in a competitive market, it should not
matter which hires which.1'... Samuelson

John R boatright (2002) observes


that ownership is a bundle of rights that
include control along with a right to
revenues and claim on physical assets.

the management accountant, February, 2009

Samuelson(1957) points out that if


capital and labor were similar input then
in a competitive market, it should not
matter which hires which. The
Corporation / Organization brings
together people with assets to realize
the benefit of joint production. It is
important that employees as well as
other output providers have incentive
to increase the value of output. Decision
making is shared in such a way that the
two groups make decision on matters
where they have superior information
and an incentive to increase the value
of the firm
Companies Act 1956, clearly
specifies that the Directors hold the
fiduciary position towards the company
and they are the trustees of money and
property. They must exercise the
powers bonafide and for the benefit of
the company as a whole. They should
not put themselves in a position where
their duties and personal interest may
conflict ( Piercy V S Mills and co Ltd(
1920) Ich77).
Corporate governance model
currently focus on the relationship
between managers and Shareholders.
Little is talked about employees and
their governance in the organization.
Such exclusive rights given, is now
questioned by some observers and
research scholars on moral grounds.
Marxian view on Ownership and Means
of Production
(Owncrs of a corporation only contribute
a tiny fraction of the total labor and time in
creating profit ... Marx

There are two subtle but important


points to the Ownership of the Means
of Production (OMP). The first being
that owning the Means of Production
is not the same thing as owning physical
property, nor is it equal to owning
money. Rather OMP refers to a cultural
practice in which a few individuals
within a corporation (or Company or
Organization) control and decide what
is done with the entire profit created by
that corporation. If one were to define
123

Emerging Issues

the word Corporation as a particular


kind of group of people then to later
say that a few select individuals own
the corporation then, by substitution,
one must be saying that those select
individuals own the group of people. In
any case, this apparent paradox only
arises when one confuses the owning
of property with the owning of a
corporation. When keeping these two
kinds of ownership separate, the
paradox of owning people evaporates.
The conclusion ultimately reached
is that while the owners of a
corporation only contribute a tiny
fraction of the total labor and time in
creating profit, they have complete
control over that profit and how it is
used. The practice of OMP in human
societies is then a type of game where
some people are labeled owners (Marx
used the term, Bourgeoisie) and other
people are labeled workers (Marx used
the term, Proletariat). The bourgeoisie
have complete control over both how
the proletariat are paid in wages and
complete control over how the profit
from production is used, thus giving rise
to a class division.
Contrarian interpretations of this
practice might state that wages paid to
workers are subsumed under the regular
costs of maintaining business. However,
Marx considered it a reifi-cation to treat
labor as just another factor in
production; it implied an inversion of
means and ends, so that people were
effectively used as things.
Employee Governance
John R. Boatright in his article on
Employee Governance and the
ownership of the firm, argues that
workers should have control over the
matters that affect them. It is the right
of individuals to freedom and autonomy.
Employee governance can induce
employees to invest in organization
specific human capital. This may further
increase employee loyalty and make
them more engaged Ultimately this may
increase the value of the organization.
124

Fama Eugene F (1980) has argued that


lower level managers are often good
monitors of higher level managers.
In Indian environment, Companies
Act 1956 and clause 49 popularly known
for corporate governance, emphasizes
on the control and decision making
powers in the hands of share-holders.
They have exclusive right towards
certain corporate decisions and
management. These powers are given
on the basis of ownership theory.
Shareholders are the residual claimant
for an organization and they receive
what is left of the companys earnings
after all other contractually required
payment are made.
Statues such as Companies Act and
Corporate Governance Clause 49 are
vague as to how directors should weigh
the various interest groups. Employee
may be argued for residual claimant.
They possess the skill and knowledge
specific to the organization and may be
of little use if employed elsewhere.
Applying this logic employees are also
like share holders have an interest with
the long term value of the corporation.
Employee rights that need attention
Whistle blowing is the right given to
employees to disclose wrong doing. It is
the part of freedom of conscience.

Indian constitution provides certain


fundamental rights to their citizen.
Similarly there are certain employee
rights which need attention by all
employers. What are the basic rights of
the employees?
a. Hours of work: From years,
governing the hours of work has
been an unending battle. It only
seems to have worsened today.
Many managers are unable to honor
the work hours stipulated by law. In
trying to inspire employees to go
beyond the call of duty many have
made it a rule that employees go far
beyond the call of duty every day.
Factories Act Chapter VI specifies
the working hours for adult workers.

b. Right to take time off: While


employees are entitled to time off as
per law, many organizations do not
take efforts to ensure that employees
are able to avail themselves of this.
While for the some employees
struggle to take a day off every
week, some others struggle to get
their paid annual leave. Better
managed companies make it
mandatory for their employees to go
on annual leave. This not only
energize their employee, give
opportunity to spend time with
family but also act as an internal
control mechanism.
c. Right to a harassment and
discrimination free workplace:
With the increase in the number of
women employees, organizations
need to sensitize their supervisors
and managers about potential
sexual harassment issues. Similarly,
managers need to ensure that they
do not practice any form of
discrimination or micro inequality
(small wrong doings). In Public
Sector undertaking(PSUs) the
government has made it mandatory
to have a policy guideline on these
issues.
d. Right to a fair performance review:
With so much at stake around the
performance review, there is
significant pressure on managers
and HR to ensure that the appraisal
process is seen as fair. The current
situation is far from satisfactory. In
fact, performance reviews are the
greatest source of employee
unhappiness today. Manuel G
velasquez ( 2002) observes that
according to the rational view of the
firm, it is one of the obligation of the
employer to provide the employees
with fair compensation.
Unfortunately there is no simple rule
or formula for determining fair
wages. Fair wage depends on the
following factors:

the management accountant, February, 2009

Emerging Issues
l Market condition,
l Cost of living
l Demand and supply of the ,
l And organizational ability to pay.

As a social responsibility the


government have brought legislations
on minimum wages.
e. Working Condition, health and
safety: It is the obligation of the
employer to provide a healthy and
safe working condition by providing
necessary resources, supervision,
proper system of working. Many
companies provide health insurance
to their employees.
f. Privacy: Privacy is the right the
employees have to determine what,
to whom, and how much information
about themselves shall be disclosed
to others. This is one of the
important right of the employee and
is being threatened / vulnerable due
to high tech technology.
g. Right to redress of grievances:
Every aggrieved employee expects
that he will be heard and his
grievance will be redressed. This
means that the employee must know
the redress process and the process
must actually work. The grievance
could be relating to poor
infrastructure, rude supervisory
behavior, incorrect pay, and so on.
A good grievance system should
provide the following;
l Written account of the grievance,
when it goes past to various levels
l Alternate routes of appeal so that
employee can bypass the
supervisor,
l Time limit to redress the grievance
l Permission for employee to have
one or two co- workers to
accompany him at each interview or
hearing.
Whistle blowing is the right given
to employees to disclose wrong doing.
It is the part of freedom of conscience.
In course of performing a job an

employee may discover something


wrong done or he/ she believes is
injurious to society. For example,
employees are the first to learn the
corporation/ organization is marketing
unsafe product or violating the law.
Trends in employee governance and
management.
The countrys labor market will
influence the flexibility and mobility of
employees. Country such as the U.S that
have employment at will where by a
contract can be terminated at any time
are likely to have flexible labor market
and short term labor commitment. In
more rigid labor markets such as
Germany and Japan companies invest a
great deal in training that tends to result
in more highly skilled labor forces and
company specific skills. These in turns
are less transferable from one company
to another. For example in France, the
union rights are extended to all
employees regardless of union
affiliation. Here unionization will have
greater influence on corporate decision
making than in U.S or U.K where only
union members benefits from collective
bargaining agreements. Japanese
companies tend to have enterprise
unionism, which leads to collective
bargaining at company level, and grant
a strong voice to employees. In 2004
for example employee opposition to job
losses prevented the restructuring
through merger with a foreign partner
of France who is financially troubled
Alstom, a major producer of ships and
trains. In the same year Volkswagen
despite suffering from very high labor
cost had to promise its Western
Germany employees job security until
2011 in exchange for a wage freeze until
2007 and more
In the past, government partly
assumed this role of protecting
employee interests through labor law,
legislation preserving private pensions,
and other workplace regulations.
Unions also played an important part.
As globalization and technology alter

the management accountant, February, 2009

the nature of work and business, new,


more efficient corporate governance
designs may yet emerge.
But in todays high-tech companies,
where value is created through custom
services and innovation, the specialized
skills and efforts of employees are
critical ingredients in creating new
wealth. Thus, Blair argues, unless
corporate governance mechanisms take
account of their interests and protect
their firm-specific investments, we risk
slowing productivity and economic
growth.
When an unexpected event, such
as a change in technology or an increase
in global competition, results in
declining demand, it matters who is in
charge. If shareholder interests control
corporate decisions, the firm will tend
to view past promises to these workers
as an avoidable cost, and will cut
production and employment more than
is efficient. A firm may undervalue the
destruction of their specialized ski/Is
and ignore the lost production and
search costs in matching employees
with new jobs. Since the firm faces an
immediate decline in demand, it may also
discount the impact on employees
long-term incentives to make future
firm-specific investments.
One way to avoid such problems is
by writing a contract that spells out ail
future obligations of the parties. But, in
practice, it is impossible to imagine and
write down a contract that covers all
eventualities. Most employment
arrangements rely a great deal on trust
and implicit promises, rather than
written, legally enforceable agreements.
In the talent short market, most of
the organizations today do want to
provide their employees with a great
work environment. Recognizing the
fiduciary duty in favor of employees the
organizations are looking into the
various ways to get them involved in
the Corporate Governance. The
measures adopted are:
125

Emerging Issues

a. Measures related to governance and


participation:
l Board level representations
l Constructive employee union
l Profit sharing ( ESOP)
l Voluntary participation.
l Involvement in quality circles
decision making
b. Management through better pay
and perks such as:
l Extend benefits to all employeeso Accommodation,
o Subsidized canteen,
o Conveyance and pick and
drop facility,
o Memberships in professional institutions and club
o Loans for purchasing car,
house at subsidized rates,
o Furnishing allowances,
o Leave travel concessions for
family,
o Loans for marriage
o Telephone allowances
c. Welfare Measures
l Group insurance, Medical
coverage to take care of the
health of employee and family
d. Working environment
l Flexi work hours, work place and
work arrangement
l Posting near hometown
l Permanent Part time
e. Safety at work place
f. Security
l One of the key facility that is
given by PSUs is the security of
jobs
l After retirement care such as
pension, medical etc
g. Caring Management
Shareholders long-run interests are
probably well-served by including
employees in corporate governance. It
126

is also beneficial to shareholders for


increasing the value of the organization.
In fact, many go well beyond compliance
and excel in many areas. There is no
lack of intent. Organizations however
seem to underestimate the effort
required to implement what they or the
law promises. As in business, the
problem is not the lack of a great
strategy. The problem is around
execution.
The corporate governance is based
on the following foundations such as
l Peoples are more important than
processes,
l Share Holders accountability,
l Effectiveness of Audit,
l Disclosure and Transparency,
l Regulatory Discipline,
Peoples are more important than
processes
Recent corporate collapses in the
U.S.A and in Europe gives an important
lesson that no Corporate Structure can
guarantee success if the individual with
in it do not operate with the right degree
of independence with the right kind of
expertise and do not devote the
required amount of time.
Share Holders Accountability
Companies
need
active
shareholders to make their views heard.
Share holders must accept their own
responsibilities to achieve a truly
robust corporate governance system.
Effective Audit
The external audit must be
independent and penetrating. The
Enron case has already an important
consequence for the Audit functions
in U.S.A. It certainly appears that, in
some cases, auditors have lost sight of
their essential function as agent of
shareholders and lost sight of public
interest dimension of their role. If
investors cannot be confident that the
prime responsibility of the auditor is to
his or her professional standard and to

market integrity, then they will lose


confidence leading to lower share prices
and higher cost of capital.
Disclosure and Transparency
The disclosure and transparency
are crucial to market integrity. Over the
last 15 years as concern about corporate
governance have grown, a series of
codes of practice have been put
together. Enron points up the danger of
incentives for directors to take huge
financial risk which bring immediate
financial benefit to them and longer term
disaster for the company.
The main principle is that the
companies should disclose in their
annual report and accounts whether
they meet the terms of these codes of
good practice. Remuneration policies
are a particularly crucial feature of
corporate governance today.
Regulatory Discipline
The prime responsibility for
developing codes of good corporate
governance has rested with companies
themselves.
Effective corporate governance
requires a clear understanding of the
respective roles of the board and of
senior management and their
relationships with others in the
corporate structure. Corporate
governance is also related to corporate
financial goals. It is a naTve assumption
that such goals are culture free.
Need of the hour:
Lot more needs to be done to protect
the rights of employees. There always
seem to be reasons for not being able
to do so business pressures, man
power shortages, customer pressures
and bad managers. Thanks to a buoyant
labor market and high mobility, a lot of
these issues are getting resolved
through attrition. What is also helping
is the fact that most Indians are not
rights oriented and still believe and
expect that their organizations will take
care of them. If we do not do enough,

the management accountant, February, 2009

Emerging Issues

we may lose this trust before long.


Employees are likely to become cynical
about organizations and their espoused
values. The steps to be taken are:
l Ensure that all HR professionals

are aware of the laws that are


meant to protect employee
rights.
l Need to install systems of audit

that give regular feedback about


the efficacy of the processes.
Employee Rights(ER) metrics
should be given as much
importance as HR metrics.
l

Such information are to be


disclosed as a part of corporate
governance report Shareholders
should understand that their
organizational survival depends
on the skilled employees who
invest their labor along with
capital.

l The information about employee

satisfaction, training, absenteeism, long hours of working,


percentage of such working,
medical and welfare expenditures, Whistle blowing mechanism, employee grievance
system, policies of sexual
harassment, percentage of
woman employees, safety and
security of employees etc
should be disclosed as a part of
corporate governance report.
( See Figl)

There is a distinction between the


interests of stakeholders and of
stockholders in an enterprise.
Stakeholders, broadly defined as
society as a whole, are interested in the
collateral benefits derived from the
success of the enterprise, such as the
abundance of a product or a service, a
clean environment, or a general rise in
the standard of living. Stockholders
have a dual interest in the success of
the enterprise:
a. direct interest as a reward for
their investment, and
b. collateral benefit as stakeholders.
Similar benefits are enjoyed by
management and employees based on
their close association with the
enterprise. Therefore, for stockholders,
management, and employees with
empowered relationships, the success
of the enterprise becomes a shared goal.
Conclusion...
If we keep doing what we are doing
we are going to keep getting what we
are getting
Stephen Covey
The basis of good governance is the
organizational culture and positive
attitude of every employee. Let me give
an example for a value system from You
can Win by Shiv Khera. There was a
man taking a morning walk at a beach.
He saw that along with the morning tide
came hundreds of star fish and when

the tide receded, they were left behind


and with the morning sun rays they
would die. The tide was fresh and the
star- fish were alive. The man took a
few steps, picked one and threw it into
the water. He did that repeatedly.
Right behind him there was another
person who could not understand what
this man was doing.. He caught up with
him and asked, What are you doing?
What difference does it make ? This
man does not reply, took two more
steps, picked up another one and threw
it into the water and said it makes a
difference to this one. This is what
the culture and value. No person was
honored for what he received. Honor
has been the reward for what he gave.
Leaders should nurture and develop
these values and make systems to
integrate various stake holders in the
governance process by proper policy,
transparency, disclosure and incentives.
Such Organization are self governing,
involved and committed. The leader
may change but the culture lives along
with the foundations of good
governance. Rules and regulations do
not bind these ethical organizations.
They never allow any WorldCom and
Enrons to happen. Good governance
is a journey, not destination. The
journey continues step by step for
excellence and never ends. It is eternal.
Great Things are not done by
Impulse but by a series of small things
brought together clause.q

l The directors report should

specify
the
employee
governance and the steps taken
by the management in that
direction.
l HR leaders must also take the

effort and courage to advocate


on behalf of employees and
escalate issues to the highest
levels if things dont improve.
HR must act as the
spokesperson and de facto
representative of employees.
the management accountant, February, 2009

127

Golden Jubilee Commemorative Address

Promote Profit with


Integrity
Dr. A. P. J. Abdul Kalam*

am delighted to participate in the


Golden Jubilee Convention of the
Institute of Cost and Works
Accountants of India (ICWAI) at Pune.
My greetings to the organizers, officebearers of ICWAI, costing specialists,
industrialists, economic planners and
the distinguished guests. . I would like
to talk on the topic Motto of ICWAI:
Promote Profit with Integrity.
National Ethics and sustainable
development
Profit with integrity leads to
sustained growth. How is it possible?
We need to have National ethics for
sustained growth and peace. Where
from it starts?
(a) Nation has to have ethics in all its
tasks, for sustained economic
prosperity and peace.
(b) If nation is to have ethics; society
has to promote ethics and value
system.
(c) If society is to have ethics and value
system, families should adhere to
ethics and value system;
(d) If families have to get evolved with
ethics and value system,
parenthood should have inbuilt
ethics.
(e) Parental ethics come from great
learning, value based education and
creation of clean environment that
leads to righteousness in the heart.
Righteousness
Where there is righteousness
in the heart,
There is beauty in the character.
*Bharat Ratna and Former President of India.
Golden Jubilee commemorative address
delivered at the Golden Jubilee Convention
of ICWAI, Pune on 15th January 2009.

128

When there is beauty in the character,


There is harmony in the home.
When there is harmony in the home.
There is an order in the nation.
When there is order in the nation,
There is peace in the world.
So friends, finally the beauty in the
character, harmony in the home, order
in the nation and peace in the world
emanates from the righteous hearts.
Righteous hearts can be evolved only
by three people, who are they? They
are father and mother and a primary
school teacher. Now you understood
the linkage.
While I was addressing the
Company Secretaries rendering value
added services to the corporate both in
the public and private sectors in January
2008, I referred about the document
prepared by the Institute of Companies
Secretaries of India on Corporate
Governance released in November 2007,
particularly, I liked the statement in the
document about the situation arising
out of India achieving full capital
account convertibility.
It was stated I quote in a couple of
years, India will have full capital account
convertibility. When that happens and
Indian investor who has rupees 36 to
spare will seriously consider whether
to put it in Indian company or to place it
with a foreign mutual fund. What does
all this mean for better corporate
governance? Everything. The loyalty of
a typical Indian investor is far greater
than its counterparts in USA or Britain.
But our Indian companies must not
make the mistake of taking such loyalty
as given. To nurture and strengthen this
loyalty, our companies need to give a
clear cut signal that the words your
company have real meaning. That

requires well functioning boards,


greater disclosures, better management
practices and a more open interactive
and dynamic corporate governance
environment. Such a situation will
definitely lead to consistent support of
share holders and creditors and improve
the competitiveness of Indian
companies. Members of ICWAI have a
very important role to play in realizing
this goal.
National challenges
Friends, we are meeting at a time
when the whole country is experiencing
a shock wave by an unfortunate
happening in the corporate sector. From
the points of view of our national pride,
investor confidence and employee
reassurance, I am sure that a
professional body like you will
contribute expeditiously to systemic
studies and root cause analysis so that
such an event is not allowed to repeat
in the country.
With a strong will, the country is on its
march towards development. The
progress is visible in many sectors.
Citizens are willing to contribute their
might to the development actions. Still
we have to overcome certain
bottlenecks.
Despite a political vision, well
articulated schemes, and adequate
fundings, many major programmes are
not on schedule and the benefits are
not reaching the intended beneficiaries.
How can we reverse this trend through
better organisation, better transparency,
better feed back, better visibility of
timely actions through purposeful
auditing ?
Now I would like to share with you
two of my personal experiences.
Efficacy of Close Loop Guidance and
Control
Let me first give you an event based
experience of the missile programme
which has similarity to the mission of
auditing. When I see the role of cost
controllers, I am reminded of technical
events taking place in sequence in the
case of flight trajectory. Let me refer to

the management accountant, February, 2009

Golden Jubilee Commemorative Address

the launch of the Agni missile system.


It is a controlled and guided flight from
the time of launch till it reaches the
target at long range. At t=0, the time of
launch, automatic launch control system
gives the take off signal, after testing
more than 600 parameters in few
seconds. If all the parameters are within
the specified error band, computer gives
a go-ahead signal. The missile lifts off.
The missile has an onboard computer
that carries the specified trajectory
which is to be followed by the missile
from the time it lifts off till it reaches the
specified impact point. Any deviation
from the trajectory is detected and
quantified by the computer and fed
continuously to the control system of
the missile. The control system operates
the fast reaction thrusters in all the three
axes of flight and corrects the deviation
and brings the missile to ride on the
required trajectory in real time. If the
corrective action is not done in real time,
the missile will reach far away from the
target and the mission will be a failure.
Guidance and control with its onboard
computer acts as the brain of the
missile. During the flight of the missile,
it is essential to guide the missile in real
time to the target to meet the mission
requirements and succeed. From this
guided missile flight example I would
like to share the following experience.
As you can see, if the correction is
provided after the event is over, the
mission will not succeed. Similarly, if the
cost controllers recommendations are
delayed beyond the completion of the
event, they will see but they are too late
to correct. I am sure you can realize the
importance of providing online cost
control advice to ensure successful
accomplishment of the mission for the
given cost, time and performance.
Technology denial management
Let me narrate another incident
which took place in 1998. In 1992, the
LCA team had decided to go for DigitalFly-by-Wire Control System (FCS) for
Combat Aircraft as it is an unstable
aircraft. At that time, the country did
not have the experience in developing

FCS. We chose LMCS for the contract


since they had the experience in
designing digital Fly-by-Wire system
for F-16 Aircraft. Joint Team for design
and development of the FCS was formed
with ADE (DRDO Labs) and LMCS. The
work share between the Indian team and
LMCS team was identified. Evolution
of the SRS was a joint effort. The
prototype flight control computer was
to be done by ADE. Total system
integration was a joint responsibility.
Flight certification was to be provided
by LMCS.
The contract progressed though a
bit slowly between 1992-98. The
defence finance was constantly
monitoring and providing an impetus
to the progress of the contract along
with our technologists. Then, as you
all are aware, India carried out its nuclear
test on 11th May 1998. As soon as this
event occurred, the American
Government imposed technological
sanction. Due to the sanction, LMCS
broke the contract and retained all the
Indian equipment, software and the
technical information which were in
their premises.
This was definitely a shock for the
Indian team. Immediately, I called for a
meeting of Directors of ADA, NAL,
ADE, CAIR, HAL, National Flight Test
Centre, Prof I.G. Sharma, a renowned
control system specialist, Prof Goshal,
a noted digital control system expert and
guidance and control specialists from
DRDL and ISRO along with our financial
advisors. The FCS team explained to
these members the situation arising out
of the unilateral termination of contract
by LMCS. Finance team with their
critical outlook and probing questions
participated in all the discussions. We
had a full day discussion on the
methodology, which needed to be
followed, by which we could
successfully complete the development
of digital fly wire system and fly the
LCA. The team after prolonged
deliberations gave a structured method
by which the development could be

the management accountant, February, 2009

completed and the system could be


certified for flight trials.
Based on the recommendations of
the specialists we immediately
strengthened the ADE software team
with an additional ten experienced
software engineers from ADA. ADA
was given the responsibility of
verification and validation of software.
The integrated flight control system
review committee was constituted with
Director (ADE) as Chairman and PGD
(ADA) as Co-chair to support
development and resolve all the
conflicts arising between Control Law
Team, Iron Bird, Software, Hardware and
simulation. This team met once in a
week and brought out all the issues
arising in different work centres and
solutions were found. In addition, an
Iron Bird review team was formed with
Project Director Flight Control System
as Chairman with members from HAL,
ADA, ADE, certification agency
(CEMILAC) and Test Pilots from the
National Flight Test Centre as Members.
This team also met every week and
resolved all the problems arising in the
development and Tests on Iron Bird. We
also introduced participation of
certification agency (CEMILAC) and
inspection agency (CRI) in all these
reviews. The aim was to see that any
problem in any system is brought into
focus at the earliest so that the solution
can be found. The confidence building
took place by intensifying the tests. For
example informal Iron Bird test was
carried out over thousand hours and
the formal Iron Bird test was conducted
over hundred and fifty hours. Similarly,
the pilot flew the simulator for more than
two thousand hours. Thus, what we
missed from the foreign partner, we
compensated by enhancing the critical
design review and increasing the test
time to ensure safe man rated design of
the integrated flight control system.
The entire team took the denial as a
national challenge. They said if it were
going to take three years we would do
it in two years. If it was going to take
twenty million dollars we would do it in
129

Golden Jubilee Commemorative Address

ten million dollars. This event reassured


me that no country could dominate us
by imposing technological sanction or
economic sanction. The collective
power of scientific, managerial and
financial management team will defeat
the challenges from any nation. Now,
LCA is entering into production phase.
I would suggest members of ICWAI to
analyse such success stories and draw
lessons for cost reduction of
indigenous programme.
Important Partnership of Defence
Finance in LCA
In respect of LCA, I would like to
mention another important feature. As
you may be aware, the full scale
engineering development Phase I of the
programme was sanctioned at a cost of
Rs.2188 crore. While sanctioning the
programme in 1993, we envisaged
building two prototypes only namely
TD-1 and TD-2. Later, the ADA team in
partnership with finance revised the
programme by increasing the number
of prototypes from two to four. This was
acclaimed as one of the very important
milestones for LCA and the people who
participated in this great work were Shri
Siva Subramaniam, FA(DS), Shri K.P.
Rao, FA(ADA) and Shri R. Ramanathan,
Additional FA(DRDO). This could be
achieved because of the online
collective decision making system
instituted by them for the programme.
During the commencement of the
programme many items were proposed
to be imported. While progressing the
programme the project team in
consultation with cost accountants
resorted to indigenous development
and manufacture of those items leading
to substantial savings in cost. Also,
the CFC Wing programme was
contracted for half the planned amount
through hard negotiations. In all these
areas, there was excellent partnership
among scientists, technologists, user
service and cost accountants. In the
LCA management system, Secretary
(Defence Finance) is a member both in
the general body and in the governing
council. The Additional (Finance
130

Advisor) from DRDO is the member in


the Technical Committee. This close knit
system had enabled the development
of a state of the art aircraft at a relatively
very low cost.
Now let me discuss the economic
environment prevailing in the country.
Economic Environment
For the past few weeks, I was
asking myself what type of innovation
is needed to enrich the Indian economy
and other world economies which are
presently in turbulence. I had
discussion on this subject with the
experts at Indian Institute of
Management Ahmedabad few days
back. It came to light that the Indian
economy will be less affected due to
the world financial crisis. This is due to
(i) the Indian banking system has
always been conservative which has
prevented the crisis (ii) The
liberalization process in India has its
checks and balances consistent with the
unique social requirements of the
country (iii) The Indian psyche is
generally savings oriented and living
within means is part of the mind set.
This situation has reduced the effect of
global turbulence in the Indian economy.
However, the resultant effect will be
reduction in export and reduction in
outsourcing. The drop in annual growth
rate of GDP could be around two
percent. This is the time we need
innovation in our thinking to rejuvenate
the agricultural sector particularly
through value addition and the small
and medium scale industries and
enterprises for making higher levels of
contribution to the GDP as I have
discussed before. As you are well aware,
we need to ignite the minds of our talents
in the rural population for new product
ideas which are not only useful to the
national consumption but also for
export market. Our numbers could lead
to reduction in unit costs. For this we
have to quickly enable the village
complexes with urban amenities. We call
this PURA (Providing Urban Amenities
in Rural Areas), by which physical,
electronic and knowledge connectivities

are ensured for creating economic


connectivity. Friends while looking at
the investments and quick actions
needed for these 7000 PURA complexes
for the whole country, I would urge this
community of cost and works
accounting professionals to reflect on
the following aspects:
1. What will be the loss of manpower
talent and loss of resource
mobilization opportunities if the
PURA implementation is delayed
every six months?
2. How can we miss opportunity for
product developments in number
and quality by harnessing our latent
talent and abilities?
3. We have to simultaneously improve
agricultural GDP, food processing
and at the same time train people
coming out of agriculture into
manufacturing and service sectors.
4. With the development of PURAS
and tier II cities, we can make cities
also perform better with lesser
problems of urbanization, visible
day by day.
Law of development
Last few years, I have been studying
the development patterns and the
dynamics of connectivity among
nations, especially in trade and
business. As you all know the world
has few developed countries and many
developing countries. What is the
dynamics between them and what
connects them? Developed country has
to market their products in a competitive
way to different countries to remain as
developed country. The developing
country to get transformed into
developed country; they too have to
market their products to other countries
in a competitive way. Competitiveness
is the common driving factors between
the two types of nations.
Competitiveness has three dimensions:
quality of the product, cost
effectiveness and product is in the
market just-in-time. Indeed this
dynamics of competitiveness in
marketing of products by developing

the management accountant, February, 2009

Golden Jubilee Commemorative Address

and developed countries is the law of


development. There is a relationship
between the core competence and the
competitiveness of the country. Such a
law applies to individual companies as
well. As you have seen one of the
important dimensions determining
competitiveness is cost. Hence, all of
you assembled here have a role to play
in working out strategies through which
you can reduce the cost of exportable
products especially when there is a
global economic turbulence and a
demand reduction.
Status of Accounting by ICWAI
During the last four decades role of
CMAs has undergone a change under
new economic environment. Initially it
was the role for price determination, i.e.
cost plus profit = selling price, which
has completely changed to manage
your costs in such a fashion that you
earn profit, hence selling price less
margin = cost. In additional to the
traditional techniques used by CMAs
such as Standard costing, Marginal
costing, Uniform Costing and so on,
new techniques coping up with the
modern technology have been evolved.
The concepts now widely used are life
Cycle Costing, Kaizen Costing and
value engineering.
Knowledge propels non-linear growth
I had an interesting study with my
team. From the study I could find among
the Top IT companies in India, per capita
revenue per employee varies from
$32,000 to $82,000 per annum, whereas
one of our Indian automobile industries
the value addition per employee is
$205,000, which is second in the world
in manufacturing. But at the same time,
I have studied certain IT MNCs whose
business is based on Knowledge
products. Their per capita employee
revenue is in the order of $200,000 to
$600,000. Per capita revenue of one of
the leading search engine company is
over 10 lakh dollars. Here you should
see the difference. Why I am bringing
this point here is, to emphasize how the
unique knowledge through their
Intellectual property can bring non-

linear growth to the organization as well


as to the nation. Higher the growth of
knowledge and better outsourcing
systems, better will be the employee
productivity leading to non-linear
growth of the company. I would suggest
ICWAI to incorporate such bench
marking system for various industry, so
that Indian industry can definitely
become internationally competitive.
Contribution to Industry
My study of the development and
spread of Cost Audit in India indicates
that only 2000 odd companies covering
44 Industries are covered under Cost
Audit in the last 43 years. If we have to
succeed in the globalized world, we have
to enlarge the scope of Cost Audit to
cover all aspects of manufacturing and
service sector activities including
healthcare and education. In the golden
jubilee year, I have the following
suggestions for ICWAI:
(a) Preparing a case for bringing all
institutions having a turnover of
over rupees 200 crore within the
purview of cost audit.
(b) Creating a campaign of special cost
audit for export oriented
manufacturing and service
industries, so that the cost of the
products are reduced at least by
10% to make them competitive
during the global recession phase.
(c) Creating a team of specialists who
can work on cost audit with quality
improvement and lifecycle costing
to make our infrastructure projects
like roads, bridges, ports, metros,
highly cost effective, so that India
can develop rural and urban
infrastructure at a fast pace and
reduced cost.
(d) Working out a costing system for
agricultural produce and agroprocessed food, so that economics
and productivity are transformed
into higher revenues for our farmers
through farmer cooperatives leading
to inclusive growth.

the management accountant, February, 2009

Conclusion
I have seen three dreams which have
taken shape as vision, mission and
realization. Space programme of ISRO
(Indian Space Research Organization),
AGNI programme of DRDO (Defence
Research
and
Development
Organization) and PURA (Providing
Urban Amenities in Rural Areas)
becoming the National Mission. Of
course, these three programmes
succeeded in the midst of many
challenges and problems. I have worked
in all these three areas. I want to convey
to you what I have learnt on leadership
from these three programmes:
a. Leader must have a vision.
b. Leader must have passion to realize
the vision.
c. Leader must be able to travel into
an unexplored path.
d. Leader must know how to manage a
success and failure.
e. Leader must have courage to take
decisions.
f. Leader should have nobility in
management.
g. Leader should be transparent in
every action.
h. Leader must work with integrity and
succeed with integrity.
For success in our mission of
integrated development of the nation,
we have to create large number of
creative leaders. Creative leadership
means exercising the vision to change
the traditional role from the commander
to the coach, manager to mentor, from
director to delegator and from one who
demands respect to one who facilitates
self-respect. For a prosperous and
developed India, the important thrust
will be on the generation of a number of
creative leaders from all walks of life
including cost audit.
My best wishes to all the members
of ICWAI success in the mission of
reducing the cost of all products and
services delivered by the Indian
industries and thereby making India
internationally competitive in all fields.
May God Bless You.q
131

Finance

Non-performing Assets
Management of Non-banking
Financial Companies:
An Introspection
Dr. Jafor Ali Akhan*
The Non-Banking Financial Companies (NBFCs) have been playing a very
significant role in the present day rigorous money-market conditions. They are
serving the nation by supporting the economic reconstruction and giving a
booster to industrial production. They are engaged into the business of providing
loans and advances of small amounts for a short-period to small borrowers. The
activities of NBFCs carries credit risk, which arises from the failure of the borrower
to fulfill its contractual obligation by not paying interest or instalments in time.
The level of non-performing assets is an important indicator of the performance
of NBFCs. The research paper makes an attempt to highlight the present level of
NPAs of NBFCs and different reasons thereon along with different remedial
measures to control NPAs.
Introduction
he Non-Banking Financial
Companies (NBFCs) play an
important role in channelizing
these savings into investment. They
have supplemented the role played by
the banks. While functioning as
financial intermediaries between the
savers and the users, they have catered
to the different segments of the society.
NBFCs have made great strides in recent
years and are meeting the diverse
financial needs of the economy. They
have greatly influenced the direction of
savings and investments. Thus, from
the macro economic perspective and the
structure of the Indian system, the role
of NBFCs has become increasingly
important.
The main function of NBFC is to
collect deposits as their resources and
invest the funds in their core activities
be it leasing or hire-purchase or
investments or granting loans. The loan

Senior Lecturer in Commerce, Kabi Nazrul


College, Murarai, Birbhum, West Bengal.

132

is the core asset of an NBFC as it is the


primary income earner for the NBFC.
Lending activities of NBFCs carries
credit risk, which arises from the failure
of the borrower to fulfill its contractual
obligation by not paying interest or
instalments in time. Non recovery of
lease rents or hire-charges or loan
instalments and interest thereon
negates the effectiveness of this
process of credit cycle. The high level
of NPAs of this sector and other
financial institutions is not desirable for
economic growth of the country and
smooth flow of credit to the society. This
creates adverse effects as well as safety
of small depositors funds and increase
the risk on bank deposits. Hence, there
is an urgent need for a relentless effort
from all concerned to reduce the NPAs
of the NBFC sector. The RBI came out
with a package of regulations on this
issue on 2.1.1998.
With this in the backdrop, the
present paper makes an attempt to
highlight the NPAs management of
NBFCs in India during the period 2002-

2007. The paper covers only those


NBFCs which are registered with the
RBI as deposit taking institutions.
Classification of Assets of NBFCS
The NBFCs having NOF of Rs. 25
lakhs and above, registered with RBI
and accepting or holding public
deposits are required to comply with the
prudential norms. Classification of
assets is an important prudential norm
for NBFCs. In compliance with the
prudential norms NBFCs are required
to classify their assets on the basis of
their performance. The word
performance implies collection of lease
rent/ hire charges/ loan installments etc.,
borrowers financial position,
availability of security etc. The assets
are required to be classified into two
broad categories:A. Performing Assets:Performing assets means standard
assets in RBI terminology. These are the
assets in respect of which NBFCs has
been collecting dues in time.
B. Non-Performing Assets:Non-Performing assets means the
assets in respect of which the NBFC
has not been collecting its dues in time.
According to Amendments to NBFC
Regulations made by the RBI on
1.8.2003, these assets are again
classified, on the basis of extent of
default, into three groups:
(i) Sub-standard Assets:Sub-standard asset is an asset which
has been classified as non-performing
for a period not exceeding eighteen
months instead of the present norm of
twenty four months.
(ii) Doubtful-Assets:Doubtful-asset is an asset which has
been classified as non-performing for a
period exceeding eighteen months
instead of present norm of twenty four
months.
(iii) Loss- Assets:Loss-asset is an asset which has been
identified as loss asset by

the management accountant, February, 2009

Finance

(a) NBFC; or
(b) External auditors; or
(c) Internal auditors; or
(d) RBIs inspector during inspection.
From the above discussion it has
been observed that any NPA will be either classified as sub-standard or loss
asset at the first instance. After it had
become sub-standard asset then only
it can become doubtful. The doubtful
asset can also become loss asset. This
can be easily shown by the following
diagram.
DIAGRAM
NPA
(At first instance)

Sub-standard Asset
Loss Asset

Becomes Doubtful Asset

Becomes Loss Asset


According to new norms issued by
RBI regarding NPAs for NBFCs on
4.8.2003, a sticky loan will be classified
as NPA if the instalment or the interest
remains overdue for six months.
However, the lease and hire-purchase
assets will turn sticky if the installment
remains overdue for more than a year.
In this connection, it has been
mentioned that the RBI earlier had
abolished the past due concept for
commercial banks. Keeping in view that
the prudential norms for NBFCs are
similar to those applicable to commercial
banks, the concept of past due has
been abolished from the definition of
NPA for NBFCs.
Different Reasons of NPAs of NBFCs
When the loans and advances made
by an NBFC or financial institution turnout non-productive and non-rewarding
they become Non-performing Assets
(NPAs).
There are various reasons attributed
for an account becoming non-

performing. These are stated below one


by one:(i) Willful Default
Willful default is one of the causes
of an account becoming nonperforming. This is a major problem
which affected the liquidity and credit
capacity of the NBFCs. Generally, it has
been raised from corporate clients who
defaulted in meeting their obligations
towards repayment of dues to NBFCs.
(ii) Diversion of Funds
It has been found that some clients
have used the loan amount for other
business activities except the purpose
for which it has been sanctioned. This
is called diversion of funds. It is an
important cause of an asset becoming
NPA.
(iii) Business Slow Down
NBFCS have granted loans to the
booming business but after some times
some business have gone to slow down
due to market recession. Then the
owner of such slow down businesses
have been facing financial crunch to
pay instalment or interest. In such
situation the asset becoming NPA.
(iv)Delay in Disbursement
In a competitive financial market
getting of funds at the right time is
essential for investment at the right time
but some times NBFCs are delaying in
disbursement of funds. This caused to
a loan becoming an NPA.
(v) Artificial Assets and Clients
Some NBFCs have been playing foul
games. Many artificial assets and
clients have been created by many
NBFCs. Industrial houses had floated
their own NBFCs and had drawn huge
amounts of funds as loan from the
monies raised from the market. They
need not feel to repay the loan amount
to their own subsidiaries NBFCs. These
assets are completely NPAs.
(vi) Business Failure
Failure of business of the clients is
one of the causes of an account

the management accountant, February, 2009

becoming NPA. It has been observed


that the borrower has failed to employ
the funds in profitable business due to
various causes, such as wrong
investment decision, high cost of
capital, market failure etc.
(vii) Poor Pre-sanctioning Scrutiny
Loans, hire-purchase assets and
lease assets becoming NPAs due to
poor pre-sanctioning scrutiny done by
the NBFCs. Therefore, the RBI should
tighten the sanctioning norms
regarding loan sanctioning or hirepurchase financing or lease financing.
Non-compliance of conditions of
sanctioning regulations completely
prohibited because this caused to an
asset become NPA.
(viii) Poor Monitoring And Follow Up
Action
It has been noticed that many of the
NBFCs have not adequate experience
and technical knowledge regarding
effective post sanction supervision. In
such a situation the borrowers have not
paid their lease rent, hire-purchase
instalment or loan instalment. As a
result, the accounts are becoming NPA.
(ix) High Leverage of the Borrowers
The companies which have taken
loan from NBFCs, in many cases they
have excessively reliance on borrowed
funds and invested only a small portion
from own funds. Over leverage of
borrowers caused high interest
expenditure and this may push them for
non-payment of the dues obligations
to the NBFCs.
(x) Political Interference
Sanctioning of leased assets or hirepurchased assets or extending financial
assistance sometimes influenced by
political parties. After disbursement of
funds, problems arise due to nonpayment of dues and the assets
becoming NPAs.
Non-performing Assets of NBFCs
Pursuant to the recommendations of
the Narsimham Committee and
133

Finance

Dr. A.C.Shah Committee, the RBI had


prescribed prudential norms for all types
of financial companies compulsorily
registered with it and having Net-owned
Fund (NOF) of Rs 50 lakh with effect
from 1.4.1993. In the public interest and
to regulate the credit system to the
advantage of the country, the RBI
issued NBFCs Prudential Norms
Directions on 31.1.1998. These norms
are applicable to all NBFCs excluding
Mutual Benefit Financial Companies
(MBFCs) having NOF of Rs.25 lakh and
above and accepting or holding
deposits. Prior to these new prudential
norms the NBFCs extended their credit
facilities to the unsecured loan and the
loan become NPA due to non-recovery
of interest or instalment. But they do
not make any provision for these risky
assets and in future the asset becomes
turned into loss assets. As a result, they
have faced seriously asset-liability
mismatch problem and they have gone
away with the monies of small
depositors. This is a social problem.
General people have lost their
confidence to these companies. The RBI
tries to safe-guard the interest of such
small depositors. Now the company
which does not comply fully with the
prudential norms it is not allowed to
accept public deposits. If any company
defaults in repayment of matured
deposits, it is prohibited from creating
any further assets until the defaulters
are rectified.
The high level of NPAs in NBFC
sector has been a matter of grave concern to the public because the growth
of any economy depends on the
smooth flow of credit. Therefore, NPAs
are not concern of lenders only, but all
concerned of the financial system.
Hence, there is a need for a Concorde
effort of all to recover bad loans and to
reduce NPAs. The magnitudes of NPAs
of the NBFCs and Scheduled Commercial Banks (SCBs) in India have been
provided with the help of Table No.1
From Table No.1 it has been outlined
134

that the gross and net non-performing


assets of reporting NBFCs has
experienced a steady declining trend in
recent years. The gross NPAs to gross
advances declined from 11.4 per cent in
1997-98 to 10.2 per cent in 1998-99 and
it further declined at 9.9 per cent in the
following year. Net non-performing
assets as a percentage of net advances
increased marginally from 6.7 per cent
to 7.0 per cent during 1998-99 and
increased sharply in the following year
at 9.5 per cent. In this way both gross
and net non-performing assets showed
a declining trend for the remaining
period of the study period. At the end
of March 2007 the percentage of gross
and net NPAs are only 1.9 per cent and
0.4 per cent respectively. It is an
outcome of the RBIs prudential norms
which was implanted on 2.1.1998. This
clearly evidenced a good performance
of NBFCs in NPAs management.
If we compare the performance of
NBFCs in NPAs management with the
performance of scheduled commercial
banks then it will be crystal clear that
NBFCs are better than SCBs in NPAs
management. The average gross NPAs
to gross advances for NBFCs is 8.18

while the same for SCBs is 9.06 and the


mean of Net NPAs to net advances for
NBFCs is 4.12and SCBs have 4.49. Since
the coefficient of variation of gross
NPAs to gross advances for NBFCs is
smaller than SCBs, the variability in
maintaining the gross NPAs
management of NBFCs are more stable
than SCBs. Coefficient of variation of
net NPAs to net advances of NBFCs is
greater than SCBs because the net
NPAs to net advances ratio was higher
in between the year 1999 &2000. At
present, the NBFC sector is very
cautious to reduce the net NPAs ratio
and it was only 0.4 per cent at the end
of March 2007. This will help this sector
for future development and growth.
Non- Performing Assets of NBFCs
Activity- wise:Non-banking Finance Companies
(NBFCs) are those companies which
offer various financial services such as
equipment leasing, hire-purchase,
loans, investments and others. Most
of these companies invite public
deposits for doing their business and
offer lucrative rates of return to the
investors. The deposits with these
companies are extreme insecurity

Table No.1 Showing Non-performing Assets of NBFCs and Scheduled


Commercial Banks During 1998 To 2007.
( In per cent)
Year
(end-March)

NBFCs
SCBs
Gross NPAs to
Net NPAs to
Gross NPAs to
Net NPAs to
Gross
Net Advances.
Gross
Net Advances.
Advances
Advances.
1997-98
11.4
6.7
14.4
7.3
1998-99
10.2
7.0
14.7
7.6
1999-00
9.9
9.5
12.7
6.8
2000-01
11.5
5.6
11.4
6.2
2001-02
10.6
3.9
10.4
5.5
2002-03
8.8
2.7
8.8
4.4
2003-04
8.2
2.4
7.2
2.9
2004-05
5.7
2.5
5.2
2.0
2005-06
3.6
0.5
3.3
1.2
2006-07P
1.9
0.4
2.5
1.0
Mean
8.18
4.12
9.06
4.49
S.D.
3.18
2.84
4.19
2.42
C.V (%)
38.87
68.93
46.24
53.91
Source: Compiled and computed from RBI, Report on Trend and Progress of Banking in
India, 1997-98 to 2006-07, & Hand Book of Statistics on Indian Economy 2005-06, p-117.

the management accountant, February, 2009

Finance

because bulks of their loans are


unsecured and are given to very risky
enterprises and hence they are charging
high rates of interest. The loans, which
they given for short periods, can be
renewed frequently and thus become
long-term loans. For these reasons their
assets are some times became nonperforming. Here we have to discuss
about the NPAs of NBFCs according to
their group-wise i.e. their activity-wise.
Quality of assets of different groups
shows a divergent trend. It is observed
that gross NPAs as a percentage to total
assets of equipment leasing companies,
hire-purchase finance companies and
investment companies slightly
increased during the year 2003-2004 but
subsequently declined during 20042005 and 2005-2006. Gross NPAs of loan
companies, however showed a declining
trend up to the year2004-2005 and
increased sharply during 2005-2006 as
36.5 percent. Surprisingly it has been
observed that gross NPAs of equipment
leasing and investment companies
increased during 2006-07, while those
of loan companies and hire-purchase
companies declined. In case of net
NPAs, as a percentage of net advances
of different group of NBFCs manifest
more or less same trend. Net NPAs of
equipment leasing, hire-purchase and
investment companies declined acutely
during 2005-06, while in case of loan
companies it increased sharply. On the
other hand net NPAs also depicted a
declining trend in the case of equipment
leasing and loan companies but it
increased for hire-purchase and
investment companies.
In this connection it has been
mentioned that a new category of NBFC
has entered into the market as Asset
Finance Company (AFC) since
December 2006 in real estate or physical
assets business. The gross NPAs of
AFC is only 2.2 per cent of gross
advances and net NPAs of this
company is -0.1 per cent only.
We have already mentioned earlier

that the NPAs of NBFCs may be


classified into three groups such as substandard assets, doubtful-assets and
loss assets. Based on the half-yearly
return ,submitted by the reporting
NBFCs to the RBI during the period
2002-03 to 2006-07, the classification of
assets of NBFCs is depicted by Table
No.3.
NPAs in sub-standard and
doubtful category, both in absolute
and percentage terms, in respect of
equipment leasing, hire-purchase and
loan companies increased during the
year ended March 2004 and
subsequently declined during the next
years. While in respect of loan
companies sub-stand assets, doubtful

assets and loss assets increased


sharply during the year ended March
2006. Again the quality of assets of
different groups of NBFCs as reflected
in the various categories of NPAs
remained broadly intact at the previous
years level during 2006-07, except in
case of loan companies which declined
significantly in all categories. The new
entrant AFC also showed a good
performance in NPAs management.
They hold 97.8 per cent standard assets
during their first year business
operation.
V. Remedial Measures to Control the
NPAs
NBFCs are privately owned smallsized financial intermediaries and

TABLE 2 : Showing NPAs of NBFCs Activity Wise.


( Amount in Rs. crore.)
NBFC
Group

Gross
Advances

1
AFC*
2007P
EL
2002
2003
2004
2005
2006
2007P

Gross NPAs

Net
Advance

Percent
to Assets

11525

-15

-0.1

-0.1

28.0
11.1
13.3
11.0
2.2
3.7

1330
5506
3067
4018
2786
973

351
469
344
345
-23
-21

26.3
8.5
11.2
8.6
-0.8
-2.1

15.2
5.6
7.8
7.4
-0.7
-1.9

17.1
7.8
9.0
3.8
2.5
1.8

14.8
6.8
7.3
3.6
2.4
1.6

6068
15305
9748
15544
17238
17842

410
104
253
253
74
83

6.8
0.7
2.6
1.6
0.4
0.5

5.2
0.5
2.0
1.5
0.4
0.4

2
11
15
10
1

1.6
11.9
23.8
17.2
2.8

0.1
2.1
2.6
1.8
0.1

147
90
55
58
59
31

1
8
7
10
1

0.4
8.9
12.7
17.2
2.8

0.0
1.5
1.2
1.8
0.1

3986
2707
2038
1955

549
144
142
117

13.8
5.3
7.0
6.0

10.1
4.8
4.1
5.1

3615
2503
1833
1772

177
-63
-65

4.9
-3.4
-3.7

3.3
-1.8
-2.8

690
7551

252
94

36.5
1.2

19.3
4.6

483
7548

45
91

9.3
1.2

3.4
4.4

Percent
to Assets

11799

258

2.2

2.1

1625
5969
3306
4187
2878
1035

646
932
582
514
69
41

39.7
15.6
17.6
12.3
2.4
4.0

HP
2002
2003
2004
2005
2006
2007P

6825
16489
10437
15900
17607
18079

1167
1288
942
610
444
321

IC
2002
2003
2004
2005
2006
2007P

149
93
63
58
59
31

LC
2002
2003
2004
2005
2006
2007P

Net NPAs
Percent
to
Net
Adv
8

Percent
to gross
Adv.
4

Amount

Amount

EL= Equipment Leasing Company. HP= Hire Purchase Finance Company.


IC= Investment Company
LC= Loan Company. AFC* = Asset Finance Company became effective since
December 2006.
P= Provisional
Source: - www.rbi.org.in

the management accountant, February, 2009

135

Finance

As at end March.
NBFC
Group
End
March.
1

Standard Assets.

Table 3: Showing Classification of Assets of NBFCs- Functionwise.


( Rs. in crore)
Sub-standard
Assets.
Amount Percent

Gross
Advances.

Doubtful Assets.

Loss Assets.

Gross NPAs.

Amount

Amount

Percent

Amount

Percent

10

11

12

0.0

258

2.2

11799

207
102
39
36
35

3.5
3.1
0.9
1.2
3.4

932
582
514
69
41

15.6
17.6
12.3
2.4
4.0

5969
3306
4187
2878
1035

269
226
94
212
85

1.6
2.2
0.6
0.8
0.5

1288
942
610
444
321

7.8
9.0
3.8
1.6
1.8

16489
10437
15900
17607
18079

6
0

0.2
8.9
0.0

11
15
10
1

11.9
23.8
17.2
2.8

93
63
58
59
31

88
82
61
134
8

3.2
4.0
3.1
19.4
0.1

145
142
117
252
94

5.3
7.0
6.0
36.5
1.3

2708
2038
1955
690
7551

Amount.

Percent

2007P

11540

97.8

241

2.0

15

2003
2004
2005
2006
2007P

5037
2724
3673
2809
994

84.4
82.4
87.7
97.6
96.0

520
396
383
12
4

8.7
12.0
9.2
0.4
0.4

205
84
91
21
2

2003
2004
2005
2006
2007P

15201
9495
15290
28170
17759

92.2
91.0
96.2
97.5
98.4

746
613
386
184
185

4.5
5.9
2.4
0.6
1.0

273
103
130
47
51

2003
2004
2005
2006
2007P

82
48
48
59
31

88.1
75.8
82.0
100.0
97.2

9
1
1

9.3
1.1
2.8

2
10
10
0

2003
2004
2005
2006
2007P

2563
1896
1837
438
6913

94.7
93.0
94.0
63.5
98.7

37
40
14
19
9

1.3
2.0
0.7
2.7
0.1

20
20
42
99
78

Percent

7
AFC*
0.1
ELC
3.4
2.5
2.2
0.7
0.2
HPFC
1.7
1.0
0.8
0.3
0.3
IC
2.4
15.3
16.7
0.0
LC
0.7
1.0
2.2
14.3
1.1

P= Provisional
AFC*= Asset Finance Company became effective in December 2006, ELC= Equipment Leasing Company, HPFC= Hire-Purchase
Finance Company, IC= Investment Company, LC= Loan Company, Data Source: - www.bankreport.rbi.org.in
Note: - Data relating to standard assets, Sub-standard assets and Loss assets of different group-wise NBFCs are available only from the
end March 2003 and onwards.

working in different segments of the


society where established financial
entities are not easily accessible to the
borrowers. The importance of NBFCs
in delivering credit to the unorganized
sector and to the small borrowers at the
local level in response to local
requirements is well recognized. At
present, NBFCs have become
prominent in a wide range of activities
like hire-purchase finance, equipment
leasing, consumer finance etc. We know
that financial stability is considered as
pillars of sustained and rapid economic
growth. Among various factors of
financial stability banks and NBFCs
136

non-performing loans and assets


assumes critical importance since it
reflects quality of asset, credit risk and
efficiency in the allocation of resources
to productive sectors. The problem of
NPAs is related to several internal and
external factors confronting the
borrowers. Hence, it is a great challenge
before the NBFC sector and it requires
some remedial measures to control over
the NPAs. These measures are given
below:(i) Compliance with Prudential Norms
The concept of prudential norms
has gained ground in the recent years
in the NBFC sector due to a number of

reasons. Prudential norms have been


made applicable to the NBFC sector
almost on the same lines as that of
banking sector. If the deposit taking
NBFCs comply with prudential norms
regarding asset classification, income
recognition and provisioning in respect
of bad and doubtful assets then the
problem of NPAs should be reduced.
Now it is mandatory to comply with
prudential norms of all deposit taking
NBFCs.
(ii) Good Pre-sanction Scrutiny
Due to lack of expert manpower
NBFCs have granted loans without
proper scrutiny of loan proposals. After

the management accountant, February, 2009

Finance

disbursement of funds they have


observed that the track record of
borrower in repayment of loan is not up
to the mark. Therefore, good presanction scrutiny of loan proposals
would help in better control of NPAs.
(iii) Frequent Interaction with
Borrowers
In the post sanction period of loans
and advances effective post-sanction
supervision would help in better control
of NPAs. Frequent interaction with
borrowers and discussion with them is
the best way to control NPAs.
(iv) Introduction of Know your Customer
Norms
As soon as loan proposal is
submitted by a borrower to the NBFC,
the NBFC should ask the borrower to
deposit some money in any deposit
scheme with this company. After
knowing the borrower as a customer the
NBFC can extend the financial
assistance to the borrower. Adherence
to know your customer (KYC) norms

would help in better control of NPAS.


(v) Adequate Relizable Security
NBFCs should be provided financial
assistance in the form of lease financing
or granting loans by taking adequate
realizable securities from the customers.
This would also help in NPAs control.
(vi) Obtaining Confidential Information
It has been observed that some
borrowers have maintained several
bank accounts with different banks but
have not paid instalment or interest on
dues to NBFCs. Then, if possible,
NBFCs can obtain confidential
information from banks about their bank
accounts where the customer is
maintaining account. This would help
in control the problem of NPAs.
(vii) Setting up of Debt Recovery
Tribunals
Efforts should be taken to set up
Debt Recovery Tribunals (DRTs) and
private NPA resolution agencies for
recovery from NPAs. This would help

PEOPLE AT THE HELM

to strengthen the recovery mechanism.


(viii) Formation of Asset Reconstruction Company
Various legal measures may be taken
to control the problem of NPAs. Among
them formation of Asset Reconstruction
Company is the great importance in the
context of NPAs control. Besides this
Lok Adalats and Civil Court should take
adequate measures to control over the
problems of recovery from NPAs.
(ix) Re-arrange of the Loans
Re-arrange of the loans will be the
best route to reduce NPAs. After
discussion with parties, NBFCs should
arrange for rebooking of the loans
considering problems of the clients.
Conclusion
Good pre-sanction scrutiny,
effective post-sanction supervision,
effective recovery steps and fully
compliance with the prudential norms
of RBI should help this sector to control
NPAs.q

Ref. No. G/82 (103)/12/2008


December 22, 2008
NOTIFICATION

S. Srinivasan, B.E (Hons), MBA, AICWA,


has been promoted as Managing Director
& CEO, Matrix Laboratories Limited from
1st January 2009. Over the course of his 15
year career at Matrix, Mr. Srinivasan has
handled wide range of functional areas,
including finance, sales & marketing, business
development and strategic planning. Most
recently he served as Matrixs Chief
Operating Officer.
the management accountant, February, 2009

In Pursuance of Regulation 146 of the Cost &


Works Accountants Regulations, 1959, the Council
of the Institute of Cost & Works Accountants of
India at its 250th Meeting held on December 11,
2008 has decided to open the following Chapters
of Cost Accountants.
1. Siliguri-Gangtok Chapter Cost Accountants of
ICWAI,
Uttara Apartment, 2nd Floor, 121/6,
Ashutosh Mukherjee Road
Subhash Pally, Siliguri - 734001, Dist.-Darjeeling
(W.B.)

(S. M. Galande)
Chief Executive Officer
137

Issues & Concerns

Behavioral Finance -A
Discussion on Individual
Investors Biases
(A Conceptual paper)
In this article, an attempt has been made to throw light on the investors biases
that influence decision making process. Retail investors are an important segment
in the stock market and their prudent presence is very essential for a healthy
growth of stock market. The long belief of the Efficient Market Hypothesis is
gradually being eroded. Empirical studies have time and again proved that the
irrational behaviors have caused stock market bubbles and crashes. The
knowledge so developed through the studies would provide a framework of
behavioral principles within which the investors can critically inspect their
investing decisions and if need be ,take corrective actions to hopefully make
their future financial decisions a bit more rational and a lot more lucrative as
well. To this end, the article finally, suggests for a time bound program to educate
and counsel the individual investors about the wisdom required in stock trading
and be aware of unethical and tactical practices of brokers ,shady dealings of
the companies and the insider trading.

Dr. Mahabaleswara Bhatta H.S.*


Introduction
here is a very long journey from
the utility theory of Von
Neumann Morgenstern, through
Efficient Market Theory to the present
day behavioral finance. Theoretical and
empirical evidence suggested that
Capital Asset Pricing Model , Efficient
Market Hypothesis and other rational
financial theories did a respectable job
of predicting and explaining certain
events (Robert J.Shiller ,2003). However,
as time went on, academics started to
find anomalies and behaviors that
couldnt be explained by theories
available at the time. The real world is
altogether different and in which, market
participants often behave very
unpredictably. The fact is, investors

FICWA, Professor in Finance, MBA


Department, PES School of Engineering,
Bangalore-560 100

138

frequently behave irrationally. Consider,


for example, people buying lottery
tickets in the hope of hitting the big
jackpot. From a purely logical
standpoint, it does not make sense to
buy a lottery ticket when the odds of
winning are overwhelming against the
ticket holder (roughly 1 in 14.6 crores,
or 0.0000006849%, for the famous
Powerball jackpot). Despite this, lacs of
people spend a lot of money on this
activity. The January Effect (Michael
and William, 1976),The Winners Curse
Robert Thaler, 1988) and The Equity
Premium Puzzle are the stock market
anomalies that remained unexplained by
the traditional theories. These
anomalies prompted academics to look
to cognitive psychology to account for
the irrational and illogical
behaviors(Albert Phung,2002). An
investor will participate in the capital
rising process of the company, not only

for the purpose of getting a better


dividend but also to make gains due to
capital appreciation. However, Some
investors invest purely for trading
purpose. Investors trade for both
cognitive and emotional reasons. They
trade because they think they have
information when they have nothing
but noise, and they trade because
trading can bring the joy of pride.
Trading brings pride when decisions
turn out well, but it brings regret when
decisions do not turn out well.
In recent years we find heavy ups
and downs in the share price indices.
Market bubbles and crashes are
common, inspite of advanced level
information flow and technological
assistance. Side by side ,we also
witness stock market scandals to the
utter dismay of the investors. Often, the
governments and regulatory bodies
intervene to rescue the stock market.
Since trading has been the hallmark of
investment . it is necessary that the
interests of the investors are properly
safeguarded. A discussion on the
Investors behavioral biases will throw
light on the impact of these biases on
the investment decision making
process. This light should prevail upon
the wisdom of the individual investors
to make them more and more rational
and still make a reasonably good return
on trading.
Logic and Investment behavior
The risk of loosing goes on
increasing ,as one continues trading in
stocks. Let us take an example. X invests
Rs 1,00,000 in stock M (Initial Public
Offer) with a face value of Rs 10 each.
In five years, if the share value goes up
to Rs 50 and if he sells all the shares , he
will be netting Rs5,00,000. Now, if he
wants to invest in the same type of
shares, he will have to invest entire
Rs5,00,000 without pocketing any gain.
This in reality results in no gain. On the
other hand, if he pockets Rs 1,00,000
and invests Rs 4,00,000 in low rated
shares, at Rs 40 each, he runs the risk of

the management accountant, February, 2009

Issues & Concerns

loosing, because, there may not be any


gain for such low rated shares in future.
If after two years, the value per share
comes down to Rs 30 and if he sells
such shares (fearing further decline) the
loss will be Rs 1,00,000,resulting in a
net gain of only Rs 3,00,000 over the
initial investment. On the other hand , if
the value goes up to Rs 50, the gain will
be Rs 1,00,000 resulting in a overall gain
of Rs5,00,000. The net difference is
therefore , limited to Original Investment
+ Net realization +/- gain or loss in each
trading. The investor has to continue
to take risk every time when the trading
takes place, in order to maximize the
returns. The investor is subjected to the
behavioral biases while taking the
decisions. The irrationality in the
decision gives scope for erratic
fluctuations in the stock values
resulting hi either gain or loss. In most
of the circumstances, the investors act
with emotion and use logic to justify
their actions. Now let us look in to some
of the most prominent behavioral biases
that cause irrational decisions.
Prospect Theory
Contrary to the expected utility
theory of Von Neumann-Morgenstern,
Tversky and Kahneman have found
that ,people place different weights on
gains and losses and on different
ranges of probability. Investors are
much more distressed by prospective
losses than they are happy by
equivalent gains. Investors will respond
differently to equivalent situations
depending on whether it is presented
in the context of losses or gains. They
are willing to take more risks to avoid
losses than to realize gains. Faced with
sure gain, most investors are riskaverse, but faced with sure loss,
investors become risk-takers.
The prospect theory can be used to
explain quite a few illogical financial
behaviors. For example, there are people
who do not wish to put their money in
the bank to earn interest or who refuse
to work overtime because they dont

want to pay more taxes. Although these


people would benefit financially from
the additional after-tax income, prospect
theory suggests that the benefit (or
utility gained) from the extra money is
not enough to overcome the feelings of
loss incurred by paying taxes.
Prospect theory also explains the
occurrence of the disposition effect,
which is the tendency for investors to
hold on to losing stocks for too long
and sell winning stocks too soon. The
most logical course of action would be
to hold on to winning stocks in order to
further gains and to sell losing stocks
in order to prevent escalating losses.
Salience (Anchoring) Bias
Often, the investors have the
tendency to attach or anchor their
thoughts around a reference point
despite the fact that it may not have
any logical relevance to the decision at
hand. The investors try to buy the
stocks at discount, whose prices have
recently declined from a high, in the hope
to make gain. The decision might have
been based on the irrelevant figures and
statistics. Because, the stock prices do
fall due to certain underlying
fundamentals. Kahneman and
Tversky(1974) in their paper entitled
Judgment Under Uncertainty:
Heuristics And Biases, have provided
an academic evidence of the presence
of strong anchoring effect even in
random cases.
Mental Accounting
Some Investors have the tendency
of separating the found money and the
earned money from the standpoint of
the purpose for which it is utilized.
Found money is recklessly spent where
as extra caution is used to spend earned
money , though there is no logical
reason to distinguish. Money kept
separately in a fund earning lower rate
of interest is never used to pay off a
debt with higher rate of interest. This
type of mental accounting will only
result in over all loss from investment
point of view.

the management accountant, February, 2009

Confirmation Bias
The investors would be more likely
to look for information that supports his
or her original idea about an investment
rather than seek out information that
contradicts it. They tend to confirm their
actions with the filtered data. In other
words, they try to look at only green
flags while glossing over the disastrous
red flags. As a result, this bias can often
result in faulty decision making because
one-sided information tends to skew an
investors frame of reference, leaving
them with an incomplete picture of the
situation.
Hindsight Bias
Investors have the tendency to
believe, after an event has occurred, that
they predicted it before it happened. If
investors think that they have predicted
the past better than they actually did,
they may also believe that they can
predict the future better than they
actually can. The belief that they can
easily predict the future based on the
past events may result in incorrect
oversimplifications and disastrous
investment decision.
Gamblers Fallacy
Often, Investors erroneously
believe that the onset of a certain
random event is less likely to happen
following an event or a series of
events.Investors can easily fall prey to
this gamblers fallacy. For example, some
investors believe that they should
liquidate a position after it has gone up
in a series of subsequent trading
sessions because they dont believe
that the position is likely to continue
going up. Conversely, other investors
might hold on to a stock that has fallen
in multiple sessions because they view
further declines as improbable. Just
because a stock has gone up on six
consecutive trading sessions does not
mean that it is less likely to go up on
during the next session. This is because
past events do not change the
probability that certain events will occur
in the future.
139

Issues & Concerns

Herd behavior
One of the most infamous financial
events in recent memory is the bursting
of the internet bubble. This happened
because of Herd Behavior. Investors
have the tendency to mimic the actions
(rational or irrational) of a larger group.
There are two reasons: First, is the
social pressure of conformity. Investors
have a natural desire to be accepted by
a group, rather than be branded as an
outcast. Second, is the common
rationale that its unlikely that such a
large group could be wrong. After all,
even if it is convinced that a particular
idea or course or action is irrational or
incorrect, the investor might still follow
the herd, believing they know
something that he does not.
Researchers have theorized that
investors follow the crowd and
conventional wisdom to avoid the
possibility of feeling regret in the event
that their decisions prove to be
incorrect. Many investors find it easier
to buy a popular stock and rationalize it
going down since everyone else owned
it and thought so highly of it. Even
though they loose ,they feel happy
because others have also lost!
Justification is easy when a bad event
occurs to others also. Buying a stock
with a bad image is harder to rationalize
if it goes down. The Crowd effects
have resulted in nasty turbulences in
the stock market (Showry & Tabassum,
2007)
Over Confidence
Investors are often over confident
in areas where they have some
knowledge. However, increasing levels
of confidence frequently show no
correlation with greater success.
Investors are consistently overconfident in their ability to outperform
the market, however, most fail to do so
(James Montier,2006). They see other
investors decisions as the result of
disposition but they see their own
choices as rational. They frequently
trade on the information they believe to
be superior and relevant, when in fact,
140

it is not and is fully discounted by the


market. This results in frequent trading
and consistently high volumes in
financial markets (Odean Terrance,1999).
Availability Bias
According to Efficient Market
Hypothesis, new information should
more or less be reflected instantly in a
securitys price. Investors tend to
heavily weight their decisions toward
more recent information, making any
new opinion biased toward that latest
news. Accordingly, good news should
raise a companys share price and that
gain in share price should not decline if
no new information has been released
since. But in reality, however,
participants in the stock market
predictably overreact to new
information, creating a larger-thanappropriate effect on a securitys price.
Furthermore, it also appears that this
price surge is not a permanent trend although the price change is usually
sudden and sizable, the surge erodes
over time. (Werner De Bondt and
Richard Thaler, 1985).
Market extremity
In recent years it has been
experienced that the market frequently
mispriced the stocks. This is most often
caused by human emotions of fear and
greed (Meir Statman,1988). At the
height of optimism ,greed moves the
stocks beyond their intrinsic value
,creating an overpriced market. At other
times ,fear moves prices below intrinsic
value, creating an under valued market.
Thus, as William Gross stated, markets
invariably move to undervalued and
overvalued extremes because human
nature falls victim to greed and/or fear.
How to Avoid these biases in an
investment scenario?
Following are some of the tips to
avoid being trapped by the investors
biases:
(1) It is possible to minimize the
disposition effect by using a
concept called Hedonic Framing
to change investors mental

approach. For example, in situations


where investors have a choice of
thinking of something as one large
gain or as a number of smaller gains
(such as finding Rs 1000 versus
finding a Rs 500 bill from two
places), thinking of the latter can
maximize the amount of positive
utility.
For situations where investors have
a choice of thinking of something as
one large loss or as a number of smaller
losses (losing Rs 1000 versus losing Rs
500 twice), framing the situation as one
large loss would create less negative
utility because the marginal difference
between the amount of pain from
combining the losses would be less
than the total amount of pain from many
smaller losses.
If investors try these methods of
framing, their thoughts should make
their experience more positive and if
used properly, it can help them to
minimize the dispositional effect.
(2) Anchoring can be avoided by a
rigorous critical thinking about the
figures that are used for the
evaluation of a stocks potential.
Notwithstanding the benchmarks,
the investors should evaluate each
company from a variety of
perspectives hi order to derive the
truest picture of the investment
landscape
(3) Mental accounting bias can be
avoided if the investors think that
the money is fungible. Regardless
of its origins or intended use, all
money is the same. Investors can
cut down on frivolous spending of
found money, by realizing that
found money is no different than
money that is earned by working. A
judicious utilization will result in
overall gain.
(4) Confirmation bias represents a
tendency for the investors to focus
on information that confirms some
pre-existing thought. Being aware of
it isnt good enough to prevent one
from doing it. A solution to

the management accountant, February, 2009

Issues & Concerns

(5)

(6)

(7)

(8)

overcoming this bias would be


finding someone to act as a
dissenting voice of reason. That
way investors will be confronted
with a contrary viewpoint to
examine.
Hindsight bias can be overcome by
critically inspecting the bubbles and
crashes of the stock markets in the
past.
It is important for the investors to
understand that in the case of
independent events, the odds of
any specific outcome happening on
the next chance remains the same
regardless of what preceded it. With
the amount of noise inherent in the
stock market, buying a stock
because of the belief that the
prolonged trend is likely to reverse
at any second, is irrational.
Investors should instead base their
decisions on fundamental and/or
technical analysis before determining what will happen to a trend.
While it is tempting to follow the
newest investment trends, an
investor is generally better off
steering clear of the herd. Just
because everyone is jumping on a
certain investment bandwagon
doesnt necessarily mean the
strategy is correct. Therefore, it is
necessary for an investor to always
do proper homework before
following any trend. Investors
should realize that those
investments favored by the herd can
easily become overvalued because
the investments high values are
usually based on optimism and not
on the underlying fundamentals.
However, it is also true that in some
cases ,by the time the investor takes
a decision to jump, the market would
have been slowing down.
Availability bias can be avoided if
the investors retain a sense of
perspective. While it is easy to get
caught up in the latest news, shortterm approaches do not usually yield
the best investment results. A
thorough research of the

investments made, will reveal the


true significance of recent news. It
is better to focus on the long-term
picture.
Conclusion
There is a paradigm shift of attention
from the Efficient Market Hypothesis
to Behavioral Finance. Though there is
no concrete solution to the
unpredictable human behavior, several
studies by the behaviorists have time
and again thrown light on the
consequences of wrong judgements.
These studies have helped to provide a
broader framework within which the
investors can critically inspect their
investing decisions. A set of behavioral
principles would certainly guide the
investors to be in the race continually
and yet make reasonable gains in
trading. In India, Securities Exchange
Board(SEBI) has realized the importance
of the presence of individual investors
for a healthy growth of stock market.
To this end ,there is a need for the
concerned to educate and counsel the
investors from time to time about the
wisdom required in the stock trading
and also about the unethical and tactical
practices of brokers ,shady dealings of
the companies and the insider trading.
Behaviorists need to be involved in
developing suitable programs by the
regulatory authorities that reach the
individual investors and enlighten them
about the tenets of sound and safe
trading and the possible threat of shady
dealings from the sharks in the ocean
of stock market. Investors can identify
some of the biases and apply that
knowledge to their own investment
decision making process and if need be
take corrective action to hopefully make
their future financial decisions a bit more
rational and lot more lucrative as well.
However, the behaviorists have yet
to come up with a coherent model that
actually predicts the future rather than
merely explains, with the benefit of
hindsight, what the market did in the
past. The big lesson is that theory
doesnt tell people how to beat the
market. Instead it tells us that

the management accountant, February, 2009

psychology causes market prices and


fundamental values to diverge for a long
time. Behavioral finance offers no
investment miracles, but it can help
investors train themselves how to be
watchful of their out behavior and, in
turn, avoid mistakes that will be
disastrous. Scope for research: There
is enough scope to undertake research
studies on the behavioral aspects of the
investors from different income groups,
age groups, geographical and
educational backgrounds to evolve
suitable programs.
References:
Albert Phung, 2002, Taking a chance on
Behavioral Finance, www. Investopedia.com Daniel Kahneman and Mark
Riepe, 1998,Aspects of Investor
Psychology, The
Journal of Portfolio Management. Daniel
Kahneman and Amos Tversky, 1979,
Prospect Theory:An analysis of
decision making under risk,
Econometrica.
Joshua D.Coval,David A.Hirshleifer and
Tyler Shumway,2005, Can individual
investor beat the market ? Harvard
business School Working Paper 02-45
HBS Finance Working paper 04-025.
Meir Statman, 1988, Investor
psychology and market inefficiencies
Equity
Markets and valuation methods, The
institute of Chartered financial
Analysts. Odean Terrance, 1999, Why
do investors trade too much?,American
Economic
Review,89(5),1279-1298. Odean Terrance,
1988a, Are Investors reluctant to
realize their losses?, Journal of Finance,
53,1775-1798.
Richard H.Thaler and Nicholas
Berberis,2002, A survey of Behavioral
Finance National bureau of economic
research, Working Paper 7716, Yale
School of Management. Robert J.Shiller
,2003, From efficient market theory
to Behavioral Finance,Yale
University-Cowles,Discussion Paper 1385.
Showry Mendemu and Tabassum
Sultana ,2007, Investors behavior,
PES Business review, Volume 2,Issue
1,P 43-49. Social Science Research
Network (SSRN), Abstract data base,
search results.q

141

Finance & Accountancy

Intellectual Property and its


Pervasiveness in Industry,
Trade and Commerce

acceptable basis for solving the


problem of trade-off between relevance
and reliability.

Intellectual Property(IP) has become a critical success factor for most hightechnology companies. There are many high-technology companies that rely
solely on IP assets for generating revenues and earning income. The accounting
system, as it currently exists, is asymmetric in its treatment of acquired and
internally developed IP. Balance sheets prepared according to generally accepted
accounting principles (GAAP) fail in most cases to provide investors with relevant
and timely information about the most important value creating assets of
companies. This Paper is an attempt to discover the true importance of IP and
how can it be valued as accurately as possible.

Avik Ranjan Roy*


Introduction:hat Is Intellectual Property:
Property which comes from
the Human Brain and for
which Government gives protection is
called
Intellectual
Property
Right(IPR).Trademark, Patent, copyright
are few examples of Intellectual
Property(IP). Today, it is a major asset
for many of the worlds most powerful
companies. The intellectual property of
a company is its legally protectable and
exploitable invisible assets .It is a subset of assets known as intangibles.
The term intellectual property (IP)
refers to property in a legal sense. It is
can be owned and dealt with. The legal
rights that give rise to intellectual
property are usually referred to as
intellectual property rights (IPRs).
There are several types of IPRs that
qualify as intellectual property. In the
emerging knowledge economy, IP has
become a critical success factor for most
high- But the future benefits to be
derived is uncertain. Hence valuation
cannot be made correctly. It has no
supporting documents unlike our
accounting system which is based on
objectivity. This paper is about valuing

*Research Scholar, Burdwan University

142

IP assets; valued in the context of


financial reporting.
Why IP Assets Need a Different
Valuation Approach ?
Accounting Standard 26 And
International Accounting Standard
(IAS) 38,contains valuation of
Intellectual Property.
The transaction-cost based
approach is inconsistent with the role
of IP assets. Acquired IP assets may be
valued based on transaction costs, but
valuing internally developed IP assets
according to past transaction costs is
not a feasible proposition. In most cases
the transactions that give rise to an IP
asset cannot be objectively identified.
For example, patents developed over a
long period have no identifiable costs.
Even if the costs of developing an IP
asset are identified, those costs may not
bear any relationship to the assets
actual value. This is an important reason
why most internally developed IP
assets are not reported on the balance
sheet. Accounting standard setters are
grappling with the issue, but the
mismatch between accounting
principles and the appropriate valuation
of IP and similar assets continues to
exist. They are yet to develop an

IP assets are different in many


significant respects from the traditional
assets. Many of IP assets are contexts
specific. In most cases, the real value of
an IP asset depends to a great extent
upon the ability of the company owning
the asset to utilize it efficiently and
effectively. The value in most cases also
depends upon the ability of the
company to exclude others from using
the asset. Because of this, it becomes,
often difficult to determine reliable ways
of assigning values to IP assets.
Considerable research in recent years
has gone into solving the problems of
valuation of IP and other intangible
assets and, consequent upon which,
some valuation models have been
developed (e.g., Intangible Assets
Monitor of Sveiby, the Skandia Model
and the Balanced Scorecard of Kaplan
and Norton). But none has gained
common acceptance.
Alternative Valuation Approaches:There are a number of tested ways
of valuing IP. While choosing a
valuation method a company should
first of all determine how the asset being
valued will create value for it.
An asset may create value for its
owner by generating additional
revenues, by saving costs or by giving
competitive advantage. It is the way an
asset creates value for the owner which
should determine which valuation
approach is to be adopted. An overview
of possible valuation approaches is
provided below.
(1) Discounted Cash Flow(DCF)
Approach:The DCF approach is considered as
an ideal approach for valuation of
assets. At the most fundamental level,
the value of an asset is determined by
three factors; how much it is expected
to generate in cash flows; the timings

the management accountant, February, 2009

Finance & Accountancy

of generation of those cash flows; and


the degree of uncertainty associated
with the cash flows. The DCF approach
takes into consideration all these
factors. Under this approach, the value
of an asset is the discounted present
value of its estimated future cash flows.
To apply this valuation approach it is
necessary to examine the conditions
under which the IP asset will be used
and to develop an agreed basis for
projecting future earnings and
expenditures attached to the asset. The
projected amounts are then discounted
by applying an appropriate discount
factor. The success of this approach
depends on the accuracy with which
the future cash flow projections are
made.
(2) Excess Operating Profits
Approach: The excess operating profits
approach determines the value of an
IPR asset by capitalizing the excess
profits the business expects to generate
with the help of the asset. There are
several ways in which the excess profits
may be calculated. One possible way of
computation of such profits is to make
estimates of profits the business would
earn without the asset.,i.e. to say the
profit the firm would earn in the normal
course of business had the IPR being
not inducted into the business.
(3) Replacement Cost Approach:This approach seeks to value an IP
asset by quantifying the amount of
money that would be required to replace
the asset or creating an equivalent
asset. The replacement cost approach
is based on the assumption that there
is some relationship between cost and
value.
(4) Market-Based Approach:The market-based approach values
IP assets by looking to the prices of
comparable assets which have been
traded between knowledgeable parties

at arms length in an active market. If it


is possible to identify transactions that
are exactly comparable, the approach
will work satisfactorily well. But in most
cases the search for a comparable
transaction proves to be a futile exercise.
(5) Cost / Royalty Savings
Approach:The cost savings method values
savings that the enterprise expects to
make as a result of owning the IP asset.
If the enterprise owning the asset is in a
position to calculate the costs it has
saved as a result of introducing the new
asset, it can easily arrive at a basis for
assigning an appropriate value to the
asset. Under the royalty savings
approach, the enterprise is to develop
estimates as to the amounts of royalties
it would have to pay if it were to license
an asset to generate the return it is
earning on the existing asset.
(6) Twenty-five Percent Approach: The twenty-five percent
technique is used in many cases to
value patents and technology. The
technique is based on rules of thumb.
Under this technique, the value of an IP
asset is computed as being equal to
twenty-five percent of the gross profit
earned on products that use the
services of the asset. The validity of
the technique is difficult to prove.
(7) Options-Based Approach: The options-based approach
requires the use of the concept of
options in assigning value to IP assets.
Options-based approach is currently
used in valuing financial derivatives.
But the options-based valuation model
can easily be extended to other
categories of assets. The owner of an
intellectual property has a variety of
choices as to how he will use the asset.
Option pricing models attempt to
estimate the economic values for each
of these possible choices.

the management accountant, February, 2009

The choice of valuation methods


should not be arbitrary. It should be
determined by the company
characteristics and by the way in which
the company delivers its products and
services. If the value attributed to IP
assets cannot be incorporated into the
balance sheet for technical reasons, the
information may be provided on a
supplementary basis. But this should
be done in a systematic and consistent
way.
Conclusions
Assigning a value on IP assets is a
challenging job. It is a challenging job
especially when the exercise needs to
be done in the context of preparation
and presentation of external financial
statements. But the accounting
profession should be prepared to ac
cept the challenge. It should promote
measures for revamping the existing
accounting system. The existing
financial reporting gap caused by the
failure of the accounting system to
acknowledge important assets needs to
be shortened. Effort should be made to
see to it that financial statements
provide an accurate portrait of corporate
resources
References :
1. Adapted From Website of Policy
Statement of Embassy of India.
2. Referential Notes of Dr. Uttam Kr.
Reader, Department of Commerce,
University of Burdwan, Golapbagh,
Burdwan-713104.
3. Journal on Intellectual Property,
published from Burdwan University,
Page no. 23-26, Pages 50-56.
4. Abstract from Sujit Sikdar and Pranjit
Kumar Nath, Prof. and Lecturer
respectively, of the Department of
Commerce, Gauhati University.
5. Article of Dr. Sudipti Banerjea, Prof. of
Commerce, Calcutta University, Page
No. 19-22.q

143

Legal Updates
[TO BE PUBLISHED IN THE GAZETTE OF INDIA, EXTRAORDINARY, PART II, SECTION 3, SUB-SECTION (i)]
GOVERNMENT OF INDIA
MINISTRY OF FINANCE
(DEPARTMENT OF REVENUE)
New Delhi, the 5th December, 2008
Notification No.57/2008 - Central Excise
G.S.R. (E).- In exercise of the powers conferred by sub-section (1) of section 5A of the Central Excise Act, 1944 (1 of 1944), the
Central Government, on being satisfied that it is necessary in the public interest so to do, hereby makes the following further
amendments in the notification of the Government of India in the Ministry of Finance (Department of Revenue), No. 3/2005Central Excise, dated the 24th February, 2005, namely:In the said notification, in the Table, after S. No.80 and the entries relating thereto, the following S. No. and entries shall be
inserted, namely :S. No.
81.

Chapter or heading or sub-heading or


tariff item
1701 91 00

Description of goods
Bura, makhana, mishri, hardas or
battasa (patashas)

Rate of duty
Nil

[F. No. 354/192/2008-TRU]


[Unmesh Wagh]
Under Secretary to the Government of India
Note.- The principal notification No. 3/2005-Central Excise, dated the 24th February, 2005 was published in the Gazette of
India, Extraordinary, Part II, Section 3, Sub-section (i) vide number G.S.R. 95(E) of the same date and was last amended vide
notification No.29/2008-Central Excise, dated the 28th May, 2008 which was published in the Gazette of India, Extraordinary,
Part II, Section 3, Sub-section (i) vide number G.S.R. 410(E) of the same date.
[TO BE PUBLISHED IN THE GAZETTE OF INDIA, EXTRAORDINARY, PART II, SECTION 3, SUB-SECTION (i)]
GOVERNMENT OF INDIA
MINISTRY OF FINANCE
(DEPARTMENT OF REVENUE)
Notification No. 62 /2008-Central Excise
New Delhi, the 24th December, 2008.
G.S.R. (E) - In exercise of the powers conferred by sub-section (1) of section 5A of the Central Excise Act, 1944 (1 of 1944), read
with sub-section (3) of section 111 of the Finance (No 2) Act, 1998 ( 21 of 1998) the Central Government, being satisfied that
it is necessary in the public interest so to do, hereby exempts 10% ethanol blended petrol that is a blend ,a) consisting, by volume, of 90% Motor spirit, (commonly known as petrol), on which the appropriate duties of excise have
been paid and, of 10% ethanol on which the appropriate duties of excise have been paid; and
b) conforming to Bureau of Indian Standards specification 2796,
from the whole of the additional duty of excise leviable thereon.
Explanation.- For the purposes of this exemption appropriate duties of excise shall mean the duties of excise leviable
under the First Schedule and the Second Schedule to the Central Excise Tariff Act, 1985 (5 of 1986), the additional duty of
excise leviable under section 111 of the Finance (No.2) Act, 1998 (21 of 1998), and the special additional excise duty leviable
under section 147 of the Finance Act, 2002 ( 20 of 2002), read with any relevant exemption notification for the time being in
force.
[F .No. 354/62/2008-TRU]
(Unmesh Wagh)
Under Secretary to the Government of India
144

the management accountant, February, 2009

Legal Updates

[TO BE PUBLISHED IN THE GAZETTE OF INDIA, EXTRAORDINARY, PART II, SECTION 3, SUB-SECTION (i)]
GOVERNMENT OF INDIA
MINISTRY OF FINANCE
(DEPARTMENT OF REVENUE)
New Delhi, the 7th December, 2008
Notification No.58/2008 - Central Excise
G.S.R. (E).- In exercise of the powers conferred by sub-section (1) of section 5A of the Central Excise Act, 1944 (1 of 1944), the
Central Government, being satisfied that it is necessary in the public interest so to do, hereby directs that each of the
notifications of the Government of India in the Ministry of Finance (Department of Revenue), specified in column (2) of the
Table hereto annexed shall be amended or further amended, as the case may be, in the manner specified in the corresponding
entry in column (3) of the said Table, namely :S.
No.
(1)
1.

2.

3.

4.

Notification
Amendments
number and date
(2)
(3)
23/2003-Central Excise,
In the said notification, in the Table, dated the 31st March, 2003 (i) against Sr. No. 5, for the entry in column (4), the entry In excess of Nil
Explanation.- The value of the goods shall be determined in terms of section 4 of
the Central Excise Act. shall be substituted;
(ii) against Sr. No. 5A, for the entry in column (4), the entry In excess of amount
equal to 4% of duty of excise specified in the First Schedule to the Central Excise
Tariff Act, 1985( 5 of 1986).
Explanation.- The value of the goods shall be determined in terms of section 4 of
the Central Excise Act. shall be substituted;
(iii) against Sr. No. 6, for the entry in column (4), the entry In excess of amount
equal to 4% of duty of excise specified in the First Schedule to the Central Excise
Tariff Act, 1985( 5 of 1986).
Explanation.- The value of the goods shall be determined in terms of section 4 of
the Central Excise Act. shall be substituted;
(iv) against Sr. No. 7, for the entry in column (4), the entry In excess of Nil
Explanation.- The value of the goods shall be determined in terms of section 4 of
the Central Excise Act. shall be substituted;
(v) against Sr. No. 7A, for the entry in column (4), the entry In excess of amount
equal to 4% of duty of excise specified in the First Schedule to the Central Excise
Tariff Act, 1985( 5 of 1986).
Explanation.- The value of the goods shall be determined in terms of section 4 of
the Central Excise Act. shall be substituted.
29/2004-Central Excise,
dated the 9th July, 2004
In the said notification, in the Table, in column (4),(i) for the entry 8%, wherever it occurs, the entry 4% shall be substituted;
(ii) for the entry 4%, wherever it occurs, the entry Nil shall be substituted.
3/2005-Central Excise,
In the said notification, in the Table, against S. No.73, for the entry 8% in column
dated the 24th
(4), the entry 4% shall be substituted.
February, 2005
3/2006-Central Excise,
In the said notification, in the Table, in column (4), dated the 1st March, 2006 (i) for the entry 14%, wherever it occurs, the entry 10% shall be substituted;
(ii) for the entry 8%, wherever it occurs, the entry 4% shall be substituted.

the management accountant, February, 2009

145

Legal Updates
5.

4/2006-Central Excise,
dated the 1st March, 2006

6.

5/2006-Central Excise,
dated the 1st March, 2006

7.

6/2006-Central Excise,
dated the 1st March, 2006

8.

10/2006-Central Excise,
dated the 1st March, 2006
49/2006-Central Excise,
dated the 30th
December, 2006
2/2008-Central Excise,
dated the 1st March, 2008

9.

10.

In the said notification, in the Table, in column (4), (i) for the entry 12%, wherever it occurs, the entry 8% shall be substituted;
(ii) for the entry 8%, wherever it occurs except for the entry occurring against
S. No. 22 and 27, the entry 4% shall be substituted;
(iii) for the entry Rs.220 per tonne, wherever it occurs, the entry Rs.145 per
tonne shall be substituted;
(iv) for the entry Rs.370 per tonne, wherever it occurs, the entry Rs.250 per
tonne shall be substituted;
(v) for the entry Rs.350 per tonne, wherever it occurs, the entry Rs.230 per
tonne shall be substituted;
(vi) for the entry 12% of retail sale price, wherever it occurs, the entry 8% of
retail sale price shall be substituted;
(vii) for the entry Rs.250 per tonne, wherever it occurs, the entry Rs.170 per
tonne shall be substituted;
(viii) for the entry 14% or Rs.400 per tonne, whichever is higher, wherever it
occurs, the entry 10% or Rs.290 per tonne, whichever is higher shall be substituted
(ix) for the entry 14% of the value of such gold potassium cyanide excluding the
value of gold used in the manufacture of such goods, wherever it occurs, the entry
10% of the value of such gold potassium cyanide excluding the value of gold used
in the manufacture of such goods shall be substituted;
(x) for the entry 14% of the value of material , if any, added and the amount charged
for such manufacture, wherever it occurs, the entry 10% of the value of material ,
if any, added and the amount charged for such manufacture shall be substituted.
In the said notification, in the Table, in column (4), (i) for the entry 14%, wherever it occurs, the entry 10% shall be substituted;
(ii) for the entry 12%, wherever it occurs, the entry 8% shall be substituted;
(iii) for the entry 8%, wherever it occurs, the entry 4% shall be substituted.
In the said notification, in the Table, in column (4), (i) for the entry 24%, wherever it occurs, the entry 20% shall be substituted;
(ii) for the entry 24% + Rs.15,000 per unit, wherever it occurs, the entry 20% +
Rs.15,000 per unit shall be substituted;
(iii) for the entry 14%, wherever it occurs, the entry 10% shall be substituted;
(iv) for the entry 14% + Rs.10,000 per chassis, wherever it occurs, the entry 10%
+ Rs.10,000 per chassis shall be substituted;
(v) for the entry 12%, wherever it occurs, the entry 8% shall be substituted;
(vi) for the entry 12% + Rs.10,000 per chassis, wherever it occurs, the entry 8% +
Rs.10,000 per chassis shall be substituted;
(vii) for the entry 8%, wherever it occurs, the entry 4% shall be substituted.
In the said notification, in the Table, in column (4), for the entry 8%, wherever it
occurs, the entry 4% shall be substituted.
In the said notification, in the Table, in column (4), for the entry 12%,
wherever it occurs, the entry 8% shall be substituted.
In the said notification, in the Table, in column (3), (i) for the entry 14%, wherever it occurs except for the entry occurring against
S. No. 14, 16 and 18, the entry 10% shall be substituted;
(ii) for the entry 14% + Rs.10,000 per chassis, wherever it occurs, the entry 10% +
Rs.10,000 per chassis shall be substituted.
[F. No.354/210/2008-TRU]
[Unmesh Wagh]
Under Secretary to the Government of India

146

the management accountant, February, 2009

Legal Updates
Circular No.878/16 /2008-CX
F.No. 201/19/2007-CX-6
Government of India
Ministry of Finance
Department of Revenue
Central Board of Excise & Customs
***
New Delhi dated 21st November , 2008
To
The Chief Commissioners, LTU (All)
The Chief Commissioners of Central Excise (All)
The Commissioners of Central Excise (All)
The Director General of Custom and Central Excise (All)
Subject: Instructions regarding Large Taxpayer Unit-reg.
***
Sir/ Madam,
I am directed to invite your attention to para VI of the Boards Circular No. 834/11/2006-CX dated 05.10.2006 wherein
the large taxpayers were requested to opt for e-payment of taxes. The Principal Chief Controller of Accounts, Central Board
of Excise & Customs, has reported that e-payment of central excise and service tax has since stabilized.
2.
Accordingly, this matte was reviewed by the Board. It was noted that most of the large taxpayers are already covered
under the mandatory e-payment clause. Hence, in order to ensure proper accounting of the departmental revenues, the said
para of the circular is amended as follows:
VI. Duty Payment:
As e-payment facility has been provided for payment of central excise duty and service tax, large taxpayers shall pay
the central excise and service tax dues electronically only, through internet banking. However, in case of difficulties in epayment, a large taxpayer is permitted to pay the duty through banks (except in such cases where e-payment is mandatory)
in the jurisdiction of the LTU Commissionerate only.
3.
The field formations may be suitably informed.
4.
Hindi version will follow.
Yours faithfully,
(Rahul Nangare)
Under Secretary to the Government of India

[TO BE PUBLISHED IN THE GAZETTE OF INDIA, EXTRAORDINARY, PART II, SECTION 3, SUB-SECTION (i)]
GOVERNMENT OF INDIA
MINISTRY OF FINANCE
(DEPARTMENT OF REVENUE)
New Delhi, the 7th December, 2008
Notification No. 59/2008 -Central Excise
G.S.R. (E).- In exercise of the powers conferred by sub-section (1) of section 5A of the Central Excise Act, 1944 (1 of
1944), the Central Government, on being satisfied that it is necessary in the public interest so to do, hereby exempts the
goods falling under the Chapter, heading, sub-heading or tariff item of the First Schedule to the Central Excise Tariff Act, 1985
( 5 of 1986), as are specified in column (2) of the Table below, from so much of the duty of excise leviable thereon under the
said First Schedule as is in excess of the amount calculated at the rate specified in the corresponding entry in column (3) of
the Table aforesaid.
Explanation. - For the purposes of this notification, the rates specified in column (3) of the said Table are ad valorem rates,
unless otherwise specified.
the management accountant, February, 2009

147

Legal Updates
Table
S.No.
(1)
1.

22.

Chapter or heading or sub-heading or tariff item of the First Schedule


(2)
1507, 1508, 1509, 1510, 1511, 1512, 1513, 1514, 1515, 1516 (excluding 1516 10 00), 1517
(excluding 1517 10 22) and 1518
1905 31 00, 1905 32 19, 1905 90 10 and 1905 90 20
5004, 5005, 5006 and 5007
5105, 5106, 5107, 5108, 5109, 5110, 5111, 5112 and 5113
5204, 5205, 5206, 5207, 5208, 5209, 5210, 5211 and 5212
5302, 5305, 5306, 5308 (excluding 5308 10 10 and 5308 10 90), 5309, 5310 and 5311
5401, 5404 90, 5405 00 00, 5407 (excluding 5407 10 15, 5407 10 25, 5407 10 35, 5407 10 45, 5407 10 95,
5407 20 10, 5407 20 20, 5407 20 30, 5407 20 40, 5407 20 90, 5407 30 10, 5407 30 20, 5407 30 30,
5407 30 40, 5407 30 90, 5407 41 19, 5407 41 29, 5407 42 90, 5407 43 00, 5407 44 90, 5407 71 10,
5407 71 20, 5407 72 00, 5407 73 00, 5407 74 00, 5407 81 19, 5407 81 29, 5407 82 90, 5407 83 00,
5407 84 90, 5407 91 10, 5407 91 20, 5407 92 00, 5407 93 00 and 5407 94 00) and 5408
5407 10 15, 5407 10 25, 5407 10 35, 540710 45, 5407 10 95, 5407 20 10, 5407 20 20, 5407 20 30,
5407 20 40, 5407 20 90, 5407 30 10, 5407 30 20, 5407 30 30, 5407 30 40, 5407 30 90, 5407 41 19,
5407 41 29, 5407 42 90, 5407 43 00, 5407 44 90, 5407 71 10, 5407 71 20, 5407 72 00, 5407 73 00,
5407 74 00, 5407 81 19, 5407 81 29, 5407 82 90, 5407 83 00, 5407 84 90, 5407 91 10, 5407 91 20,
5407 92 00, 5407 93 00 and 5407 94 00
5508, 5509, 5510, 5511, 5512, 5513, 5514, 5515 and 5516
5601 (excluding 5601 10 00 and 5601 22 00), 5602, 5603, 5604, 5605, 5606, 5607
(excluding 5607 50 10), 5608 (excluding 5608 11 10 and 5608 11 90) and 5609
5607 50 10, 5608 11 10 and 5608 11 90
57
5801 (excluding 5801 22 10 and 5801 35 00), 5802, 5803, 5804 (excluding 5804 30 00), 5806, 5808,
5809, 5810 and 5811.
5901, 5902 (excluding 5902 10 10 and 5902 10 90), 5903, 5904, 5905, 5906, 5907, 5908,
5909, 5910 and 5911.
60
61
62
63 (excluding 6309 00 00 and 6310)
8523 80 20
8702 10 11, 8702 10 12, 8702 10 19, 8702 90 11, 8702 90 12, 8702 90 19, 8703 23 10, 8703 23 91,
8703 23 92, 8703 23 99, 8703 24 10, 8703 24 91, 8703 24 92, 8703 24 99, 8703 32 10, 8703 32 91,
8703 32 92, 8703 32 99, 8703 33 10, 8703 33 91, 8703 33 92, 8703 33 99, 8703 90 90.
8702 90 13, 8703 (excluding 8703 23 10, 8703 23 91, 8703 23 92, 8703 23 99, 8703 24 10, 8703 24 91,
8703 24 92, 8703 24 99, 8703 32 10, 8703 32 91, 8703 32 92, 8703 32 99, 8703 33 10, 8703 33 91,
8703 33 92, 8703 33 99, 8703 90 90), 8704 10 90, 8704 31 10, 8704 31 90, 8704 32, 8704 90,
8706 00 21, 8706 00 39
8706 00 43, 8706 00 49

23.
24.

9001 30 00, 9001 40 10, 9001 40 90, 9001 50 00


9504 40 00

2.
3.
4.
5.
6.
7.

8.

9.
10.
11.
12.
13.
14.
15.
16.
17.
18.
19.
20.

21.

Rate
(3)
4%
4%
4%
4%
4%
4%
4%

8%

4%
4%
8%
4%
4%
4%
4%
4%
4%
4%
8%
20% +
Rs 20,000
per unit
20%

20% +
Rs 10,000
per chassis
4%
4%

[F. No. 354/210/2008-TRU]


(Unmesh Wagh)
Under Secretary to the Government of India
148

the management accountant, February, 2009

Legal Updates
[TO BE PUBLISHED IN THE GAZETTE OF INDIA, EXTRAORDINARY, PART II, SECTION 3, SUB-SECTION (i)]
GOVERNMENT OF INDIA
MINISTRY OF FINANCE
(DEPARTMENT OF REVENUE)
Notification No. 61 /2008-Central Excise
New Delhi, the 24 th December, 2008.
G.S.R. (E) - In exercise of the powers conferred by sub-section (1) of section 5A of the Central Excise Act, 1944 (1of 1944), the
Central Government hereby exempts Motor Spirit (commonly known as petrol) (hereinafter referred to as said goods), falling
under heading No.27.10 of the First Schedule and the Second Schedule to the Central Excise Tariff Act, 1985 (5 of 1986)
(hereinafter referred to as said Schedules), manufactured in and cleared from an oil refinery or cleared from a registered
warehouse, intended for use in ethanol blended petrol, that is, a blend,
a) consisting, by volume, of 90% Motor spirit, (commonly known as petrol) and of 10% ethanol; and
b) conforming to Bureau of Indian Standards specification 2796
from so much of the duty of excise leviable thereon under the said Schedules, as is in excess of the duty that would have been
leviable on such goods under the said Schedules, if sold by the manufacturer for delivery at the time of removal of such
goods or at any other time nearest to the removal of such goods, where the manufacturer and the buyer are not related and
the price is the sole consideration.
[F .No. 354/62/2008-TRU]
(Unmesh Wagh)
Under Secretary to the Government of India
[TO BE PUBLISHED IN THE GAZETTE OF INDIA, EXTRAORDINARY, PART II, SECTION 3, SUB-SECTION (i)]
GOVERNMENT OF INDIA
MINISTRY OF FINANCE
(DEPARTMENT OF REVENUE)
Notification No. 63 /2008-Central Excise
New Delhi, the 24th December 2008
G.S.R. (E) - In exercise of the powers conferred by sub-section (1) of section 5A of the Central Excise Act, 1944 (1 of 1944),
read with sub-section (3) of section 147 of the Finance Act, 2002 (20 of 2002), the Central Government, being satisfied that it
is necessary in the public interest so to do, hereby makes the following further amendment in the notification of the
Government of India in the Ministry of Finance (Department of Revenue), No. 28/2002-Central Excise, dated the 13th May,
2002 and published in the Gazette of India vide number G.S.R.361 (E), dated the 13 th May 2002, namely:In the said notification, in the Table, after S. No. 3 and the entries relating thereto, the following shall be inserted, namely:(1) (2)
(3)
4 10% ethanol blended petrol that is a blend ,Nil.
(a) consisting, by volume, of 90% Motor spirit, (commonly known as petrol), on which the
appropriate duties of excise have been paid and, of 10% ethanol on which the appropriate
duties of excise have been paid, and
(b) conforming to Bureau of Indian Standards specification 2796.
Explanation: For the purposes of this exemption appropriate duties of excise shall mean the
duties of excise leviable under the First Schedule and Second Schedule to the Central Excise
Tariff Act, 1985 (5 of 1986), the additional duty of excise leviable under section 111 of the
Finance (No.2) Act, 1998 (21 of 1998) and the special additional excise duty leviable under
section 147 of the Finance Act, 2002 (20 of 2002), read with any relevant exemption
notification for the time being in force.
[F. No. 354/62/2008-TRU]
(Unmesh Wagh)
Under Secretary to the Government of India
Note: - The principal notification No. 28/2002-Central Excise, dated the 13th May, 2002 was published in the Gazette of India,
Extraordinary vide G.S.R 361 (E), dated the 13th May 2002 and was last amended vide notification No.40/2004-Central Excise,
dated the 4th August, 2004, published in the Gazette of India, Extraordinary vide G.S.R 502 (E) dated the 4th August, 2004.
the management accountant, February, 2009

149

Legal Updates

[TO BE PUBLISHED IN THE GAZETTE OF INDIA, EXTRAORDINARY, PART II, SECTION 3, SUB-SECTION (i)]
GOVERNMENT OF INDIA
MINISTRY OF FINANCE
(DEPARTMENT OF REVENUE)
Notification No. 64 /2008-Central Excise
New Delhi, the 24th December, 2008.
G.S.R.(E).- In exercise of the powers conferred by sub-section (1) of section 5A of the Central Excise Act, 1944 (1 of 1944),
the Central Government, on being satisfied that it is necessary in the public interest so to do, hereby makes the following
further amendments in the notification of the Government of India in the Ministry of Finance (Department of Revenue), No.
4/2006-Central Excise, dated the 1st March, 2006 which was published in the Gazette of India, Extraordinary, part II, section 3,
sub-section (i) vide number G.S.R. 94(E) of the same date, namely:In the said notification, in the Table, (i) after S.No. 1C and the entries relating thereto, the following S.No. and entries shall be inserted, namely:-

(1)
1D

(2)
2523 10 00

(3)
All goods

(4)
Rs 300 per tonne

(5)
-;

(ii) after S. No. 24 and the entries relating thereto, the following S. No. and entries shall be inserted, namely:-

(1)

(2)

24A.

2710

(3)

(4)

(5)

10% ethanol blended petrol that is a blend ,(a) consisting, by volume, of 90% Motor spirit, (commonly known
as petrol), on which the appropriate duties of excise have been paid
and of 10% ethanol on which the appropriate duties of excise have
been paid; and
(b) conforming to Bureau of Indian Standards specification 2796.

Nil

Explanation.-For the purposes of this exemption appropriate duties


of excise shall mean the duties of excise leviable under the First
Schedule and Second Schedule to the Central Excise Tariff Act,
1985 (5 of 1986), the additional duty of excise leviable under
section 111 of the Finance (No.2) Act, 1998 (21 of 1998) and the
special additional excise duty leviable under section 147 of the
Finance Act, 2002 (20 of 2002), read with any relevant exemption
notification for the time being in force.
[F .No. 354/62/2008-TRU]
(Unmesh Wagh)
Under Secretary to the Government of India
Note: - The principal notification No.4/2006-Central Excise, dated the 1st March, 2006 was published in the Gazette of India,
Extraordinary, part II, section 3, sub-section (i) vide number G.S.R.94 (E), dated the 1st March, 2006, and was last amended by
notification No. 58/2008-Central Excise, dated the 7th December, 2008 published vide number G.S.R. 840(E), dated the 7th
December 2008.
150

the management accountant, February, 2009

Legal Updates
TO BE PUBLISHED IN THE GAZETTE OF INDIA EXTRAORDINARY PART-II, SECTION 3, SUB-SECTION (i)
GOVERNMENT OF INDIA
MINISTRY OF FINANCE
DEPARTMENT OF REVENUE
NEW DELHI, THE 6th JANUARY, 2009.
16th PAUSA, 1930 (SAKA ).
NOTIFICATION No. 4 / 2009-Customs (N.T.)
G.S.R. E.- In exercise of the powers conferred by clause (aa) of sub-section (1) of section 7 of the Customs Act, 1962 (52 of
1962), the Central Board of Excise and Customs hereby makes the following further amendment in the notification of the
Government of India in the Ministry of Finance (Department of Revenue), No.12/97-Customs (N.T.), G.S.R. No.193(E) dated
the 2nd April, 1997, namely:In the Table to the said notification, against serial number 8, relating to the State of Madhya Pradesh, after item (v), the
following items in column (3) and the corresponding entries in column (4) shall respectively be inserted, namely:(3)
(vi) Pithampur (Indore)
(vii) Ratlam

(4)
Unloading of imported goods and the loading of export goods
Unloading of imported goods and the loading of export goods.
Sd./( M.M. Parthiban )
Director (Customs)
[F.No.450/91/2008-Cus.IV]

Note: The principal notification was published in the Gazette of India vide notification No. 12/97-Customs (N.T.), dated the
2nd April, 1997 [G.S.R. No.193(E) dated the 2nd April, 1997] and was last amended by notification No.117/2008-Customs(N.T.),
dated the 12th November, 2008 [G.S.R.No.785(E), dated the 12th November, 2008].
[TO BE PUBLISHED IN THE GAZETTE OF INDIA, EXTRAORDINARY, PART II, SECTION 3, SUB-SECTION (ii) ]
Government of India
Ministry of Finance
(Department of Revenue)
Notification No. 5 / 2009-Customs (N.T.)
New Delhi, dated the 6th January, 2009.
16 Pausa, 1930 Saka.
S.O. (E). In exercise of the powers conferred by sub-section (1) of section 4 and sub-section (1) of section 5 of the Customs
Act, 1962 (52 of 1962), the Central Board of Excise and Customs for the purpose of adjudicating the Show Cause Notices
pertaining to M/s Haldex India Limited, B-71,MIDC, Ambad, Nashik, Maharashtra hereby appoints the Commissioner of
Customs (Export), Nhava Sheva, to act as a common adjudicating authority to exercise the powers and discharge the duties
conferred or imposed on the following adjudicating authorities in column 3 in respect of Show Cause Notices against their
names in column 2 of the Table below, namely:Sr. No.

Show Cause Notices No. and Date

(1)

(2)

Adjudicating Authority
(3)

DGCEI/MZU/20/3/12(4) 22/03, dated 01.04.2004

Commissioner of Customs (Export), Nhava Sheva

DGCEI/MZU/20/3/12(4) 22/03, dated 01.04.2004

Commissioner of Customs (Export), New Custom House, Mumbai

DGCEI/MZU/20/3/12(4) 22/03, dated 01.04.2004

Addl. Commissioner of Customs, Air Cargo Complex,


Sahar Airport, Mumbai

DGCEI/MZU/20/3/12(4) 22/03, dated 01.04.2004

Addl. Commissioner of Customs, Air Cargo Export, NCH, New Delhi

(M.M.Parthiban)
Director (Customs) to the Government of India
[F.No. 437/77/2007-Cus.IV]
the management accountant, February, 2009

151

Legal Updates
[TO BE PUBLISHED IN THE GAZETTE OF INDIA, EXTRAORDINARY, PART II, SECTION 3, SUBSECTION (ii) ]
Government of India
Ministry of Finance
(Department of Revenue)
Notification No. 6 / 2009-Customs (N.T.)
New Delhi, dated the 6th January, 2009.
16 Pausa, 1930 Saka.
S.O. (E). In exercise of the powers conferred by sub-section (1) of section 4 and sub-section (1) of section 5 of the Customs
Act, 1962 (52 of 1962), the Central Board of Excise and Customs hereby appoints the Commissioner of Customs, Inland
Container Depot, Tughlakabad, New Delhi to act as a common adjudicating authority to exercise the powers and discharge
the duties conferred or imposed on the Commissioner of Customs (Import), Jawaharlal Nehru Port Trust, Nhava Sheva,
Mumbai, Maharashtra, for the purpose of adjudicating the matters relating to Show Cause Notice pertaining to M/s Victory
International, WZ-219C, Madipur Village, New Delhi 110063 and others vide, DRI. F.No. 50D/138/2006-C.I., dated the 6th
August, 2008, by the Additional Director General, Directorate of Revenue Intelligence, 7 th Floor, D Block, I.P.Bhavan,
I.P.Estate, New Delhi - 110002.
(M.M.Parthiban)
Director (Customs) to the Government of India
[F.No. 437/52/2007-Cus.IV]
[TO BE PUBLISHED IN THE GAZETTE OF INDIA, EXTRAORDINARY, PART II, SECTION 3, SUB-SECTION (i)]
GOVERNMENT OF INDIA
MINISTRY OF FINANCE
(DEPARTMENT OF REVENUE)
Notification No. 60/2008-Central Excise
New Delhi, the 24th December, 2008
G.S.R. (E). -In exercise of the powers conferred by sub-section (1) of section 5A of the Central Excise Act, 1944 (1 of 1944),
read with section 91 and section 93 of the Finance (No.2) Act, 2004 (23 of 2004), the Central Government, being satisfied that
it is necessary in the public interest so to do, hereby makes the following further amendment in the notification of the
Government of India, in the Ministry of Finance (Department of Revenue), No. 32/2005-CENTRAL EXCISE, dated the 17th
August, 2005, number G.S.R.537 (E), dated the 17th August, 2005, namely:In the said notification,(i)
in paragraph 3, for clause (d), the following shall be substituted, namely:The jurisdictional excise officer shall, after satisfying himself that the said goods have been used for the specified purposes,
and on production of documentary evidence about the duty paid on the said goods, and the completion certificate and the
consolidated consumption certificate as specified in clause (ca) above, by the approved construction agency, sanction the
refund claim, at the rate of 6% of the cost of construction of such house or houses, as the case may be, subject to a maximum
of Rs.9000 per house constructed:
Provided that in respect of houses constructed by the approved agency in Andaman and Nicobar Islands, the refund claim
shall be sanctioned at the rate of 6% of the cost of construction of such house or houses, as the case may be, subject to a
maximum of Rs.21500 per house constructed; and
(ii)
in paragraph 4, the following proviso shall be inserted, namely:Provided that in respect of houses constructed by the approved agency in Andaman and Nicobar Islands, the amount of
refund shall not exceed 6% of the cost of construction or Rs.21500 per house constructed, whichever is less, in any case.
(iii)
in paragraph 5, for the figures, letters and word 31st March, 2008, the figures, letters and word 31st December, 2008
shall be substituted.
[F.No.341/2/2005-TRU (Pt)]
(Unmesh Wagh)
Under Secretary to the Government of India
Note. - The principal notification was published in the Gazette of India, Extraordinary, vide number G.S.R.537(E), dated the
17th August, 2005 and was last amended vide notification number 27/2007-Central Excise, dated the 14th June, 2007, published
in the Gazette of India, Extraordinary, vide number G.S.R. 428 (E), dated the 14th June 2007.
152

the management accountant, February, 2009

Legal Updates
[TO BE PUBLISHED IN THE GAZETTE OF INDIA, EXTRAORDINARY, PART II, SECTION 3, SUB-SECTION (ii) ]
GOVERNMENT OF INDIA
MINISTRY OF FINANCE
(DEPARTMENT OF REVENUE)
Notification No. 7 / 2009-Customs (N.T.)
New Delhi, dated the 6th January, 2009.
16 Pausa, 1930 Saka.
S.O. (E). In exercise of the powers conferred by sub-section (1) of section 4 and sub-section (1) of section 5 of the Customs
Act, 1962 (52 of 1962), the Central Board of Excise and Customs hereby appoints the Commissioner of Customs (Export),
Jawaharlal Nehru Custom House, Nhava Sheva, Raigad, Maharashtra to act as a common adjudicating authority to exercise
the powers and discharge the duties conferred or imposed on,(i) the Commissioner of Customs (Import), Jawaharlal Nehru Custom House, Nhava Sheva, Raigad, Maharashtra;
(ii) the Commissioner of Customs, New Central Excise Building, Port Area, Vishakhapatnam;
(iii) the Commissioner of Customs, New Custom House, Panambur, Mangalore;
(iv) Commissioner of Customs (Import), New Customs House, Ballard Estate, Mumbai; and
(v) the Commissioner of Central Excise, Delhi I, C.R.Building, I.P.Estate, New Delhi
for the purpose of adjudicating the matters relating to Show Cause Notice pertaining to M/s Bagsons International, 38/2079,
Naiwala, Karol Bagh, New Delhi - 5 and others issued vide, F.No. DRI/BZU/F/03/2006, dated the 25th June, 2008, by the
Additional Director General, Directorate of Revenue Intelligence, Mumbai Zonal Unit, Mumbai.
(M.M.Parthiban)
Director (Customs) to the Government of India
[F.No. 437/54/2008-Cus.IV]
[ TO BE PUBLISHED IN THE GAZETTE OF INDIA, EXTRAORDINARY, PART II, SECTION 3, SUB-SECTION (ii) ]
Government of India
Ministry of Finance
(Department of Revenue)
Notification No. 8 / 2009-Customs (N.T.)
New Delhi, dated the 6th January, 2009.
16 Pausa, 1930 Saka.
S.O. (E). In exercise of the powers conferred by sub-section (1) of section 4 and sub-section (1) of section 5 of the Customs
Act, 1962 (52 of 1962), the Central Board of Excise and Customs hereby appoints the Commissioner of Customs, Inland
Container Depot, Tughlakabad, New Delhi to act as a common adjudicating authority to exercise the powers and discharge
the duties conferred or imposed on:(i) the Commissioner of Customs (Export), New Custom House, New Delhi;
(ii) the Commissioner of Customs, Customs Commissionerate, Jaipur;
(iii) the Commissioner of Customs, Custom House, Kandla;
(iv) the Commissioner of Customs (Export), Custom House, JNPT, Nhava Sheva;
(v) the Commissioner of Customs (Export), Custom House, Chennai; and
(vi) the Commissioner of Customs and Central Excise, Hyderabad II, Hyderabad,
for the purpose of adjudicating the matters relating to Show Cause Notice pertaining to M/s Skipper Electricals India Limited,
F-667-668, RIICO Industrial Area, Phase-II, Bhiwadi and others issued vide, F.No. 840/JPR/19-XXI/2007, dated the 13th
August, 2008, by the Additional Director General, Directorate of Revenue Intelligence, Delhi Zonal Unit, New Delhi.
[F.No. 437/62/2008-Cus.IV]
(M.M.Parthiban)
Director (Customs) to the Government of India
the management accountant, February, 2009

153

Legal Updates

[TO BE PUBLISHED IN THE GAZETTE OF INDIA, EXTRAORDINARY, PART-II,


SECTION-3, SUB-SECTION (ii)]
Government of India
Ministry of Finance
Department of Revenue
[Central Board of Direct Taxes]
Notification
New Delhi, the 28th November, 2008
INCOME-TAX
S.O. 2813(E).- In exercise of the powers conferred by clause (iii) of sub-section (4) of section 80-IA of the Income-tax Act, 1961
(43 of 1961), the Central Government hereby makes the following amendments to the Industrial Park Scheme, 2008, namely :In the Industrial Park Scheme, 2008, in FORM IPS I,(i) for para 2.III, the following para shall be substituted, namely:2.III Details of industrial activity to be undertaken by industrial units:
____________________________
____________________________
____________________________
(i) for para 3.VI, the following para shall be substituted, namely:3.VI Whether all the criteria as mentioned in para 4 of the Industrial Park Scheme, 2008 are met or not:
(a) The date of commencement of the Yes/No Industrial Park should be on or after the 1st day of April 2006 and not later than
the 31st day of March 2009;
(b) The area allocated or to be allocated Yes/No to industrial units shall not be less than seventy-five per cent of the
allocable area;
(c) The area allocated or to be allocated for Yes/No commercial activity shall not be more than ten per cent of the allocable
area;
(d) There shall be a minimum of thirty industrial Yes/No units located in a industrial park;
(e) For the purpose of computing the minimum Yes/No number of industrial units; all units of a person and his associated
enterprises shall be treated as a single unit.
(f) The minimum constructed floor area shall Yes/No not be less than 15,000 square metres;
(g) No industrial unit, along with the units of Yes/No an associated enterprise, shall occupy more than twenty-five per cent
of the allocable area;
(h) The industrial park should be owned by only Yes/No one undertaking; and
(i) Industrial units shall undertake only such Yes/No industrial activity as defined in clause (j) of para 2 of the Industrial
Park Scheme, 2008
2. This notification shall come into force on the date of its publication in the Official Gazette.
[Notification No. 106/2008, F.No.149/278/2006-TPL]
(Kamlesh Chandra Varshney), Director.
Note.- The principal Scheme was published in the Gazette of India, Extraordinary, Part-II, Section 3, Sub-section (ii) vide
notification number S.O.51 (E), dated the 8th January, 2008 and was subsequently amended by notification number S.O.1605
(E), dated the 2nd July, 2008.

154

the management accountant, February, 2009

Legal Updates
Circular No 880/18/2008-CX
22nd December 2008
F.NO. 6/12/2008 CX 1
Government Of India
Ministry Of Finance
Department Of Revenue
Central Board Of Excise & Customs
Sub: Determination of the value of the excisable goods for the purposes of charging central Excise Duty in respect of
industrial units located in Jammu & Kashmir and availing VAT remission vide SRO 91 dated 16.03.05.
Representations have been received from the Trade in J&K on the above referred subject.
2
The Notification SRO-91 dated 16.03.2006 issued by the Government of J & K states that every registered industrial
unit claiming tax (VAT) remission shall make price adjustment in the selling price equivalent to the amount of tax chargeable
on the finished goods sold, where after the tax shall be charged on the net selling price so that the benefit of such price
adjustment is passed on to the purchasing dealer/consumer. In order that transparency is maintained in the transactions,
every sale invoice shall invariably mention the amount of price adjustment made in the selling price. In case no price
adjustment is made the industrial unit shall not be entitled to any tax remission. Following examples given in SRO 91 make the
scheme of remission clear:
In the case mentioned below at a there shall be no remission of tax and in respect of case mentioned at b, there shall
be remission of Tax.
a.
No remission of Tax
Qty
Description of goods
Unit price
Value (Rs.)
VAT Rate
Amount of VAT
(Rs.)
1
Transformer
10000
10000
4%
400
Total
10000
400
Total Amount Paid by the Buyer = Rs. 10,400.00 (Rs 400 is paid by the manufacturer to the state as VAT hence total
value of transaction for the manufacturer is Rs 10000)
b. Price adjustment Method for tax remission.
Unit Price
Qty
Description of
Before
Price
Net unit
Value(Rs.)
VAT
Amount of
goods
Price adj.
Adjustment
Price
Rate
VAT(Rs)
1
Transformer
10,000
384.6
9615.4
9615.4
4%
384.6
Total
9615.4
384.6
Total Amount Paid by the Buyer = Rs 10,000 ( Since no VAT is paid to the state, total value of transaction for the
manufacturer is Rs 10000)
3.
In case mentioned at a, the transaction value of Rs 10,000 is exclusive of the VAT, and the VAT of Rs 400, is charged
separately from the customer and paid to the exchequer. In this case, there is no remission of VAT by the state, and
transaction value inclusive of excise duty, for determination of the excise duty is Rs 10,000. In case mentioned at b, the
assessee has determined the assessable value taking transaction value as Rs 10,000, because for the said transaction he gets
Rs 10,000 from the customer inclusive of a notional amount of Rs 384.6 as VAT. However this VAT is not paid to the state.
Thus in both the cases transaction has earned Rs 10,000 for the assessee. This scheme implies that the VAT element is only
notional as far as the manufacturer is concerned and is neither paid nor payable to the Government. The question for
consideration is what shall be the transaction value inclusive of excise duty, for determination of excise duty in case b.
4
Section 4 defines the term transaction value as the price actually paid or payable for the goods, .........but does not
include the amount of duty of excise, sales tax and other taxes, if any, actually paid or actually payable on such goods;..
5
Further, the circular F.No. 354/81/200-TRU dated 30.6.2000 in paras Nos. 10 and 11 explains that only those taxes
which are actually paid or are payable to the concerned governments are deductible for determination of Assessable value.
Those amounts which are neither paid nor payable at a later date cannot be deducted while arriving at the assessable value.
6
In view of above, it is clarified that the VAT element indicated as price adjustment in the invoices in terms of SRO 91
and remitted by the state is not to be deducted for determining the assessable value.
7
Trade & industry as well as field formations may please be informed suitably.
8
Receipt of the Circular may be acknowledged.
9
Hindi version will follow.
(Ashima Bansal)
Undersecretary to the Government of India
the management accountant, February, 2009

155

Legal Updates

[ TO BE PUBLISHED IN THE GAZETTE OF INDIA, EXTRAORDINARY, PART-II,


SECTION 3, SUB-SECTION (ii)]
GOVERNMENT OF INDIA
MINISTRY OF FINANCE
DEPARTMENT OF REVENUE
(CENTRAL BOARD OF DIRECT TAXES )
New Delhi, the 22nd December, 2008
CORRIGENDUM
INCOME-TAX
S.O. 2949(E).- In the Notification of the Government of India, Ministry of Finance, Department of Revenue ( Central Board of
Direct Taxes), number 107/2008 dated 11th December, 2008 bearing S.O. (E) and published in the Gazette of India, Extraordinary,
Part-II, Section -3, Sub-section (ii) dated 11th December, 2008
In clause 1, sub-section (1), instead of Income-tax (11th Amendment) Rules, 2008 read as Income-tax (10th Amendment)
Rules, 2008
[Notification No. 109./2008/ F.No. 142/11/2008-TPL]
( Anand Kumar Kedia)
Director to the Government of India

[ TO BE PUBLISHED IN THE GAZETTE OF INDIA, EXTRAORDINARY, PART-II,


SECTION 3, SUB-SECTION (ii)]
GOVERNMENT OF INDIA
MINISTRY OF FINANCE
DEPARTMENT OF REVENUE
(CENTRAL BOARD OF DIRECT TAXES)
NOTIFICATION
INCOME-TAX
New Delhi, the 22nd October, 2008
S.O. 2499 (E) In exercise of the powers conferred by section 295 read with clause (xii) of sub-section (5) of section 11 of the
Income-tax Act, 1961 ( 43 of 1961 ), the Central Board of Direct Taxes hereby makes the following rules further to amend the
Income-tax Rules, 1962, namely:1. (1) These rules may be called the Income-tax ( Ninth Amendment ) Rules, 2008.
(2) It shall be deemed to have come into force with effect from the 31st day of July, 2008.
2. In the Income-tax Rules, 1962, in rule 17C, after clause (vi), the following clause shall be inserted, namely:(vii) investment by way of acquiring shares of National Skill Development Corporation.
[Notification No. 99/2008/ F.No. 142/18/2008-TPL]
( Pradip Mehrotra )
Director
Note:- The principal rules were published in the Gazette of India Extraordinary, Part-II, Section 3, Sub-section (ii) vide
Notification Number S.O. 968 (E) dated the 26th March, 1962 and was last amended by the Income-tax (Seventh Amendment)
Rules, 2008, vide Notification Number S.O. 2431 (E) dated, 10th October, 2008
156

the management accountant, February, 2009

Legal Updates
RBI/2008-09/343
A.P. (DIR Series) Circular No. 46

Date : Jan 2, 2009

External Commercial Borrowings (ECB) Policy - Liberalisation


Attention of Authorised Dealer Category - I (AD Category - I) banks is invited to the A.P. (DIR Series) Circular No. 26
dated October 22, 2008 relating to External Commercial Borrowings (ECB).
2. On a review, it has been decided to modify some aspects of the ECB policy as indicated below :
(i) As per extant ECB policy, the all-in-cost ceilings for ECBs, in respect of both Automatic as well as Approval routes are
as under:
Average Maturity Period

All-in-Cost ceilings over

Three years and up to five years

6 Months LIBOR*
300 bps

More than five years

500 bps

* for the respective currency of borrowing or applicable benchmark.


It has now been decided to dispense with the requirement of all-in-cost ceilings on ECB until June 30, 2009. Accordingly,
eligible borrowers, proposing to avail of ECB beyond the permissible all-in-cost ceilings specified above may approach the
Reserve Bank under the Approval Route. This relaxation in all-in-cost ceiling will be reviewed in June 2009.
(ii) In May, 2007, Reserve Bank had withdrawn the exemption accorded to the 'development of integrated township' as a
permissible end-use of ECB. It has now been decided to permit corporates, engaged in the development of integrated
township, as defined in Press Note 3 (2002 Series) dated January 04, 2002, issued by DIPP, Ministry of Commerce & Industry,
Government of India to avail of ECB under the Approval Route. Integrated township, as defined above, includes housing,
commercial premises, hotels, resorts, city and regional level urban infrastructure facilities such as roads and bridges, mass
rapid transit systems and manufacture of building materials. Development of land and providing allied infrastructure forms
an integrated part of townships development. The minimum area to be developed should be 100 acres for which norms and
standards are to be followed as per local bye-laws / rules. In the absence of such bye-laws/rules, a minimum of two thousand
dwelling units for about ten thousand population will need to be developed. The policy will be reviewed in June 2009.
(iii) As per the extant ECB policy, Non-Banking Financial Companies (NBFCs) are permitted to avail of ECB for a minimum
average maturity period of five years to finance import of infrastructure equipments for leasing to infrastructure projects in
India. It has now been decided to allow NBFCs, which are exclusively involved in financing of the infrastructure sector, to
avail of ECBs from multilateral / regional financial institutions and Government owned development financial institutions for
on-lending to the borrowers in the infrastructure sector under the Approval route. While considering the applications,
Reserve Bank will take into account the aggregate commitment of these lenders directly to infrastructure projects in India.
The direct lending portfolio of the above lenders vis--vis their total ECB lending to NBFCs, at any point of time should not
be less than 3:1. AD Category - I banks should obtain a certificate from the eligible lenders to this effect. This facility will be
reviewed in June 2009.
(iv) At present, entities in the services sector viz. Hotels, Hospitals and Software sector are allowed to avail of ECB up to USD
100 million per financial year for import of capital goods, under the Approval route. It has now been decided to permit the
corporates in the Hotels, Hospitals and Software sectors to avail of ECB up to USD 100 million per financial year, under the
Automatic Route, for foreign currency and / or Rupee capital expenditure for permissible end-use. The proceeds of the ECBs
should not be used for acquisition of land.
3. The modifications to the ECB guidelines will come into force with immediate effect. All other aspects of ECB policy, such
as USD 500 million limit per company per financial year under the Automatic Route, eligible borrower, recognised lender, enduse, all-in-cost ceiling, average maturity period, prepayment, refinancing of existing ECB and reporting arrangements remain
unchanged.
4. Necessary amendments to the Foreign Exchange Management (Borrowing or Lending in Foreign Exchange) Regulations,
2000 dated May 3, 2000 are being issued separately.
5. AD Category - I banks may bring the contents of this circular to the notice of their constituents and customers concerned.
6. The directions contained in this circular have been issued under sections 10(4) and 11 (1) of the Foreign Exchange
Management Act, 1999 (42 of 1999) and is without prejudice to permissions/approvals, if any, required under any other law.
Yours faithfully,
(D. Mishra)
Chief General Manager

the management accountant, February, 2009

157

Legal Updates

Deputy General Manager


Investment Management Department
Division of Foreign Institutional Investors & Custodian
Cir No. IMD/FII&C/36/2009
January 05, 2009
To
All Custodians of Securities
Dear Sir/ Madam,
Sub: Revisions in submission of reports on two way fungibility of ADRs/GDRs
Ref:- SEBI circular no. IMD/CUST/11/2003 dated December 11, 2003
1. The report prescribed in the above mentioned circular shall now be submitted by the custodians as part F of the monthly
report specified in SEBI circular dated July 21, 2008. For ease of reference the format is appended herewith.
2. In view of the above custodians need not submit the said format in hard copy or in floppies separately.
3. It has also been decided to do away with the submission of copies of contract notes to SEBI. As and when required, SEBI
shall requisition the custodians to provide the copies of the contract notes.
4. The custodians of securities are requested to take note of the above mentioned revisions.
A copy of this circular is available at the web page F.I.I. on our website www.sebi.gov.in.
Yours faithfully,
Jeevan Sonparote
Encl: mentioned as above

158

the management accountant, February, 2009

Legal Updates

(TO BE PUBLISHED IN THE GAZETTE OF INDIA, EXTRAORDINARY, PART-II


SUB SECTION (II)
GOVERNMENT OF INDIA
MINISTRY OF FINANCE
(DEPARTMENT OF REVENUE)
(CENTRAL BOARD OF DIRECT TAXES)
New Delhi, the 11th December, 2008
NOTIFICATION
INCOME TAX
S.O. 2861(E).- In exercise of the powers conferred by section 295 read with clause (iia) of sub-section (1) of section 35 of the
Income-tax Act, 1961 (43 of 1961), the Central Board of Direct Taxes hereby makes the following rules further to amend the
Income-tax Rules, 1962, namely:1. (1) These rules may be called the Income-tax (11th Amendment) Rules, 2008.
(2) They shall come into force with effect from the 1st day of April, 2009.
2. In the Income-tax Rules, 1962,after rule 5E, the following rule shall be inserted, namely:Prescribed authority, guidelines, form, manner and conditions for approval under clause (iia) of sub-section (1) of section 35.
5F. (1) For the purposes of clause (iia) of sub section (1) of section 35, the prescribed authority shall be the Chief Commissioner of Income-tax having jurisdiction over the applicant.
(2) Guidelines, form and manner in respect of approval under clause (iia) of sub-section (1) of section 35 shall be as under:(a) An application for approval under clause (iia) of sub-section (1) of section 35 by a company shall be made in duplicate in
Form No. 3CF-III, to the Commissioner of Income-tax having jurisdiction over the applicant, at any time during the
financial year immediately preceding the assessment year from which the approval is sought.
(b) The applicant shall send a copy of the application in Form No. 3CF-III to the prescribed authority, accompanied by the
acknowledgement receipt as evidence of having furnished the application form in duplicate in the office of the Commissioner of Income-tax having jurisdiction over the case.
(c) Every notification under clause (iia) of sub-section (1) of section 35 shall be issued or an order rejecting the application
shall be passed within a period of twelve months from the end of the month in which the application was received in the
office of the Chief Commissioner of Income-tax.
(d) If any defect is noticed in the application in Form No. 3CF-III or if any relevant document is not attached thereto, the
Commissioner of Income-tax shall serve a deficiency letter on the applicant before the expiry of one month from the date
of receipt of the application form in his office.
(e) The applicant shall remove the deficiency within a period of fifteen days from the date of service of the deficiency letter
or within such further period which, on an application made in this behalf may be extended, so however, that the total
period for removal of deficiency does not exceed thirty days, and if the applicant fails to remove the deficiency within the
period of thirty days so allowed, the Commissioner of Income-tax shall send his recommendation to the Chief Commissioner of Income-tax for treating the application as invalid.
(f) The Chief Commissioner of Income Tax may, after examining the recommendations referred to in clause (e), pass an order
that the application is invalid.
(g) If the application form is complete in all respects, the Commissioner of Income-tax may, make such inquiry as he may
consider necessary regarding the genuineness of the activity of the company and send his recommendation to the Chief
Commissioner of Income-tax for grant of approval or rejection of the application before the expiry of the period of three
months to be reckoned from the end of the month in which the application form was received in his office.
(h) The Chief Commissioner of Income-tax may, before granting approval under clause (iia) of sub-section (1) of section 35,
call for such documents or information from the applicant as it considers necessary and may get any inquiry made for
verification of the genuineness of the activity of the applicant.
(i) The Chief Commissioner of Income-tax may, under sub-section (1) of section 35, issue the notification to be published in
the Official Gazette granting approval to the company or for reasons to be recorded in writing reject the application.
the management accountant, February, 2009

159

Legal Updates

(j) The Chief Commissioner of Income -tax may withdraw the approval granted under clause (iia) of sub-section (1) of
section 35 if he is satisfied that the company has ceased to carry on its activities or its activities are not genuine or are not
being carried on in accordance with all or any of the conditions under this rule :
Provided that no order treating the application as invalid or rejecting the application or withdrawing the approval shall be
passed without giving a reasonable opportunity of being heard to the company.
(k) A copy of the order invalidating or rejecting the application or withdrawing the approval shall be communicated to the
applicant, the Assessing Officer and the Commissioner of Income-tax.
(3) Approval to a company under clause (iia) of sub-section (1) of section 35 shall be subject to the following conditions,
namely:(a) The sum paid to the company shall be used for scientific research;
(b) The applicant company shall carry on scientific research through its own employees using its own assets;
(c) A company approved under clause (iia) of sub-section (1) of section 35 shall maintain separate books of account in
respect of the sums received by it for scientific research, reflect therein the amount used for carrying on research, get
such books of account audited by an accountant, and furnish the report of such audit duly signed and verified by
such accountant to the Commissioner of Income-tax having jurisdiction over the case, by the due date of furnishing
the return of income under sub-section (1) of section 139. Explanation.- For the purpose of this clause accountant
shall have the same meaning as assigned to it in Explanation to sub-section (2) of section 288 of the Act.
(d) The company shall maintain a separate statement of donations received and the amount used for research and a copy
of such statement duly certified by the auditor shall accompany the report of audit referred to in sub-rule (3).
(e) Subsequent to approval, the company shall, every year, by the due date of furnishing the return of income under subsection (1) of section 139, furnish a statement to the Commissioner of Income-tax containing the following information, namely:(i) a detailed note on the research work undertaken by it during the previous year;
(ii) a summary of research articles published in national or international journals during the year;
(iii) any patents or other similar rights applied for or registered during the year;
(iv)programme of research projects to be undertaken during the forthcoming year and the financial allocation for such
subjects.
(f) If the Commissioner of Income-tax is satisfied that the company,
(i) is not maintaining separate books of account for research activities, or
(ii) has failed to furnish its audit report, or
(iii) has not furnished its statement of the sums received and the sums used for research, or a statement referred to in
subclause (e),or
(iv) has ceased to carry on its research activities, or its activities are not genuine, or
(v) is not fulfilling the conditions subject to which approval was granted to it,
he may after making appropriate enquiries, furnish a report on the circumstances referred to in sub-clauses (i) to (v)
to the jurisdictional Chief Commissioner of Income-tax within six months from the date of furnishing the return of
income under sub-section (1) of section 139.
3. In the Income-tax Rules, 1962, in Appendix II, after Form 3CF-II, the following form shall be inserted, namely: FORM NO. 3CF-III
[See rule 5F]
Application form for approval under clause (iia) of sub-section (1) of section 35 of the Income-tax Act, 1961 in the case of
company
1. (i) Name and address of the registered office of the applicant.
(ii) Enclose a copy of the Memorandum and Articles of Association, and if the company was approved earlier, furnish
notification number and date of the latest notification. [Please enclose a copy]
160

the management accountant, February, 2009

Legal Updates

2
3

8
9

10

(iii) If approval was withdrawn in the past, mention reasons on account of which the approval was withdrawn. [Enclose
a copy of the Order/Orders withdrawing approval/approvals]
(iv) Date from which approval has been sought for.
Legal status of the applicant: (Enclose a copy of certificate of incorporation)
(i) Address(es) of the research laboratory/research facility of the applicant.
(ii) Year of establishment.
(iii) Name and address of the Officer in-charge of the Laboratory/research facility.
(iv) Total number of employees engaged in scientific research.
List of research facilities or assets acquired by the applicant:
(i) Plant and machinery.
(ii) Land and building along with cost of acquisition.
(iii) Any other research facility/asset along with cost of acquisition.
Research subjects and projects undertaken by the applicant:
(i) Research projects completed by the organization during last three years, if any.
(ii) Research projects which have been taken up during the year and research projects which are underway from the past
years.
(iii) Research papers published in any eminent national or international research journal.
Other details of scientific research :
(i) New products, processes, methods, techniques developed.
(ii) Improvements in existing products, processes, methods, techniques.
(iii) Import substitution.
(iv) Patents filed: obtained, if any, and if so, in whose name?
(v) Whether products, processes methods and techniques mentioned at (i) above have been commercialized or implemented and if so, by whom?
(vi) New theories/models developed.
(vii) New hypothesis which has been widely accepted.
(viii) Any copyrights applied for/obtained.
(ix) Earnings from patents or registered trade marks, if any.
Enclose details of seminars, conferences, workshops, and training courses, etc., conducted by the applicant during the
last three years and a brief note regarding the relevance of such exchanges to the research area or activity carried on by
the applicant.
Programmes contemplated for research in future and financial projections to meet the likely expenditure on such
programmes.
(i) Sources of income of the applicant (for the last three years)
(ii) Indicate assessment particulars:
(PAN, Ward/Circle if assessed to tax)
(iii) When was the last return of income furnished?
Amount received by the company and actually applied for research conducted by it during the last three years:
Year
Amount received
Amount actually utilized for
research out of the amount
at column (2)
(1)
(2)
(3)

the management accountant, February, 2009

161

Legal Updates

Circular No. 106 /9 /2008-ST


F.N0.137/84/2008-CX.4
Government of India
Ministry of Finance
Department of Revenue
(Central Board of Excise & Customs)
New Delhi, dated the 11th December, 08
Sub:- Filing of claim for refund of service tax paid under notification No. 41/2007-ST dated 6/10/2007-reg.
Notification No. 41/2007-ST, dated 6/10/2007 allows refund of service tax paid on specified services used for export of
goods. The Board has from time to time examined the procedural difficulties arising in implementation of this refund scheme.
In this context, a circular (No. 101/4/2008-ST, dated 12.5.2008) was issued earlier whereby the procedural difficulties that were
being faced by the merchant exporters and the exporters having multi location offices were resolved. Subsequently, notification
No. 32/2008-ST, dated 18.11.2008 has also been issued to (i) extend the period of filing of refund claim by the exporter from 6 0
days to six month and from the end of the quarter to which such refund claim pertains; and (ii) allow refund on testing service,
without any copy of agreement with the buyer of goods, if such testing and analysis is statutorily stipulated by domestic
rules and regulations.
2. The Board has received further references from field formations and trade seeking clarification on other procedural
issues. Trade has also reported delays in sanction of refund claims. These issues and the clarification for streamlining of
procedures are discussed below.
3. ISSUE No. I: The procedure for availing refund, under the aforesaid notification, by a manufacturer exporter not
registered with central excise is as under:
(i) He shall file the claim with the central excise authority having jurisdiction the over factory of manufacture [para 2
(b)(i) of the notification];
(ii) He shall file a declaration in the format given in the annexure to the notification. The CX authority would issue a STC
No. (Service Tax Code) to him [para 2 (c) and 2(d) of the notification].
The issue raised by some of the exclusive Central Excise Commissionerates is that they do not have access to the System for
Allotment of Service Tax Payer Code (SAPS). Hence, exclusive Central Excise Commissionerates in places like Delhi and
Bangalore have not been able to process the refund claims filed by the manufacturer exporter not registered with central
excise.
CLARIFICATION: The Directorate of Systems has reported that there is no restriction for exclusive Central Excise
Commissionerates in having access to SAPS. Therefore, exclusive Central Excise Commissionerates, not having access to
SAPS at the moment, may approach the Directorate of Systems to get the access to the centralized software.
4. ISSUE NO. II: One of the conditions of the notification is that the exporter claiming exemption has actually paid the
service tax on the specified services [para 1(c) of the notification]. The other condition is that the refund claim shall be
accompanied by document evidencing payment of service tax [para 2(f) (ii) of the notification]. In this regard the following
issues have been raised.
(i) Whether the invoices/bills/challan issued by the service provider, showing service tax amount could be treated as
evidence that the exporter has paid the service tax.
(ii) The invoices produced by the exporters are at times not complete (i.e. does not have STC code of service provider)
(iii) One to one correlation between payment of ST and invoice is difficult in many cases.
CLARIFICATION: The invoices/challans/bills issued by supplier of taxable service, in conformity with rule 4A of the
Service Tax Rules, 1994, are reasonable evidence that the services on which refund is being sought are taxable service. The
compliance of condition that exporter has actually paid the service tax rests with the exporter claiming refund. Therefore, in
so far as this condition is concerned, the refund claim should be processed based on furnishing of appropriate invoices/
bills/ challan by the person claiming refund and undertaking to the effect of payment of service tax by him. For the purposes
of compliance verification, random checks should be carried out independently and where the refund amount is significant,
post refund audit may also be carried out.

162

the management accountant, February, 2009

Legal Updates

As regards incomplete invoices/bills etc,., rule 4A of the Service Tax Rules, 1994 prescribes the statutory requirement.
Compliance of this rule requires that the invoices/challan/bills should be complete in all respect. Therefore, the exporter
claiming refund of service tax under notification No. 41/2007-ST should ensure in their own interest that invoices/bills/
challan should contain requisite details (name, address and registration No. of service provider, S. No. and date of invoice,
name and address of service receiver, description, classification and value of taxable service and the service tax payable
thereon). Refund claim cannot be allowed on the basis of invoices not having complete details as required verification
cannot be carried out by the department on the basis of incomplete invoices.
5. ISSUE NO. Ill: Vide instruction F. No. 341/15/2007-TRU, dated 17.4.2008, direction has been issued that refund claim be
disposed of within thirty days. Commissioners have stated that it is not practically feasible in all cases to dispose of the
refund claim within this time frame in view of procedural and other issues involved in processing of claim.
CLARIFICATION: The difficulties arising in processing of claims may be brought to the notice of the Board. The procedural
difficulties brought so far to the notice of the Board have been clarified earlier vide circular No. 101/4/2008-ST, dated
12.5.2008 and vide this circular. This should enable the field formations to dispose of the pending refund claims expeditiously.
Therefore, every effort should be made by field formations to adhere to the prescribed timelines.
The Board has further decided that simplified procedure for refund, as prescribed by the Board vide circular No. 828/5/
2006-CX dated 20.4.2006 for sanction of refund/rebate of unutilized CENVAT credit under rule 5 of the CENVAT Credit Rules,
2004/rebate would mutatis mutandis apply to refund claims under notification No. 41/2007-ST. Under this simplified procedure,
80% of the due refund amount is sanctioned as adhoc interim refund to specified category of exporters having good track
record, within 15 days of filing of a refund claim, subject to the condition that refund claim is complete and contains the
requisite documents. For this purpose, the specified category of exporters would be (i) all exporters having export turnover
of more than Rs 5 crore in the current or preceding financial year; (ii) PSUs including PSUs of State Governments; (iii) Star
Export Houses as specified under Chapter 3.5 of the Foreign Trade Policy, 2004-2009; (iv) manufacturer-exporters registered
with Central Excise who have been exporting during the previous two financial years and have minimum export of Rs. 1 crore
or more during the preceding financial year, (v) exporters registered with service tax or central excise who have paid central
excise duty and/or service tax amounting to Rs. 1 crore or more during the preceding financial year; (vi) All Export Oriented
Units.
6. Wide publicity may be given (in the form of trade notices, advertisements) to make the stakeholders aware of the above
clarification and compliance should be monitored. Any difficulty faced in processing of refund claims under aforesaid
notification may be immediately brought to the notice of the undersigned.
Yours faithfully,
(Gautam Bhattachraya)
Commissioner (ST)

the management accountant, February, 2009

163

DEPARTMENT IDS
S. No.
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12
13
14
15
16
17

Department/Activity
A&F, Delhi Office
A&F, HQ, Kolkata
CEO, ICWAI
Continuing Education Programmes, PD&P
Cost Accounting Standards Board
Examinations Department
Information Technology Department
Membership Department
Newsletter
Public Information Officer, ICWAI
Research & Journal
SAFA
S C Gupta, JD
Secretary, ICWAI
Studies Department
Technical Department
Training & Placement Department

E-Mail Id
admn_delhi@icwai.org
finance@icwai.org
ceo@icwai.org
mdp@icwai.org
casb@icwai.org
exam@icwai.org
it@icwai.org
membership@icwai.org
newsletter@icwai.org
pio@icwai.org
research@icwai.org
safa@icwai.org
gupta@icwai.org
secretary@icwai.org
studies@icwai.org
technical@icwai.org
training@icwai.org

CENTRAL COUNCIL MEMBER IDS


S. No.
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15

Department/Activity
Shri Kunal Banerjee
Shri AS Durga Prasad
Shri AG Dalwadi
Shri BM Sharma
Shri SR Bhargave
Shri VC Kothari
Shri AN Raman
Shri GN Venkataraman
Shri M Gopalakrishnan
Shri Sanjiban Bandyopadhyaya
Shri SC Mohanty
Shri Somnath Mukherjee
Shri Balwinder Singh
Shri Chandra Wadhwa
Shri Hari Krishan Goel

E-Mail Id
president@icwai.org
vicepresident@icwai.org
dalwadi@icwai.org
bmsharma@icwai.org
bhargave@icwai.org
kothari@icwai.org
anraman@icwai.org
gnv@icwai.org
mgopala@icwai.org
sanjiban@icwai.org
mohanty@icwai.org
smukherjee@icwai.org
balwinder@icwai.org
wadhwa@icwai.org
hkgoel@icwai.org

CHAPTER IDS
S. No.
1
2
3
4
5
6
7
8
164

Area
NIRC
EIRC
SIRC
WIRC
Ahmedabad
Aurangabad
Baroda
Bhilai

E-Mail Id
nirc@icwai.org
eirc@icwai.org
sirc@icwai.org
wirc@icwai.org
ahmedabad@icwai.org
aurangabad@icwai.org
baroda@icwai.org
bhilai@icwai.org
the management accountant, February, 2009

CHAPTER IDS
S. No.
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40
41
42
43
44
45
46
47
48
49
50
51
52
53
54
55
56
57

Area
Bhopal
Bilaspur
Chandrapur
Goa
Indore-Dewas
Jabalpur
Jhagrakhand-Chirimiri
Kalyan-Ambarnath
Kolhapur-Sangli
Korba
Konkan
Kutch-Gandhidham
Nagpur
Nasik-Ojhar
Pune
Rajkot
Surat-South Gujarat
Vindhyanagar
Bangalore
Bhadravati-Shimoga
Cochin
Coimbatore
Godavari
Hyderabad
Kolar Gold Fields
Kothagudem
Kottayam
Madurai
Mangalore
Mettur-Salem
Mysore
Nellai-Pearl City
Neyveli
Palakkad
Pennar
Pondicherry
Ranipet-Vellore
Tiruchirapalli
Thrissur
Trivandrum
Ukkunagaram
Vijayawada
Visakhapatnam
Agartala
Asansol
Bokaro Steel City
Cuttack Bhubaneswar
Dhanbad-Sindri
Durgapur

the management accountant, February, 2009

E-Mail Id
bhopal@icwai.org
bilaspur@icwai.org
chandrapur@icwai.org
goa@icwai.org
indore@icwai.org
jabalpur@icwai.org
jhagrakhand@icwai.org
kalyan@icwai.org
kolhapur@icwai.org
korba@icwai.org
konkan@icwai.org
kutch@icwai.org
nagpur@icwai.org
nasik@icwai.org
pune@icwai.org
rajkot@icwai.org
surat@icwai.org
vindhyanagar@icwai.org
bangalore@icwai.org
bhadravati@icwai.org
cochin@icwai.org
coimbatore@icwai.org
godavari@icwai.org
hyderabad@icwai.org
kolargold@icwai.org
kothagudem@icwai.org
kottayam@icwai.org
madurai@icwai.org
mangalore@icwai.org
mettur_salem@icwai.org
mysore@icwai.org
nellai@icwai.org
neyveli@icwai.org
palakkad@icwai.org
pennar@icwai.org
pondicherry@icwai.org
ranipet@icwai.org
tiruchirapalli@icwai.org
thrissur@icwai.org
trivandrum@icwai.org
ukkunagaram@icwai.org
vijayawada@icwai.org
visakhapatnam@icwai.org
agartala@icwai.org
asansol@icwai.org
bokaro@icwai.org
cbc@icwai.org
dhanbad@icwai.org
durgapur@icwai.org
165

CHAPTER IDS
S. No.
58
59
60
61
62
63
64
65
66
67
68
69
70
71
72
73
74
75
76
77
78
79
80
81
82
83
84
85
86
87
88
89
90
91
92
93
94
95
96
97
98
99
100
101
102
103
104
105
166

Area
Farakka
Gangtok-Siliguri
Guwahati
Howrah
Jaipur-Keonjhar
Jamshedpur
Kalyani
Kharagpur
Naihati-Ichapur
Patna
Rajpur
Ramgarh
Ranchi
Rourkela
Sambalpur
Serampore
Silchar
Talcher Angul
Ajmer-Bhilwara
Allahabad
Chandigarh-Panchkula
Dehradun
Faridabad
Ghaziabad
Gorakhpur
Gurgaon
Hardwar-Rishikesh
Jaipur
Jalandhar
Jhansi
Jodhpur
Kanpur
Kota
Lucknow
Ludhiana
Mankapur
Naya Nangal
Noida
Patiala
Jammu Srinagar
Udaipur
Dubai
Nepal
Sultanate of Oman
Zambia
Tanzania
Botswana
South Orissa

E-Mail Id
farakka@icwai.org
gangtok@icwai.org
guwahati@icwai.org
howrah@icwai.org
jaipur@icwai.org
jamshedpur@icwai.org
kalyani@icwai.org
kharagpur@icwai.org
naihati@icwai.org
patna@icwai.org
rajpur@icwai.org
ramgarh@icwai.org
ranchi@icwai.org
rourkela@icwai.org
sambalpur@icwai.org
serampore@icwai.org
silchar@icwai.org
talcher@icwai.org
ajmer@icwai.org
allahabad@icwai.org
chandigarh@icwai.org
dehradun@icwai.org
faridabad@icwai.org
ghaziabad@icwai.org
gorakhpur@icwai.org
gurgaon@icwai.org
hardwar@icwai.org
jaipur@icwai.org
jalandhar@icwai.org
jhansi@icwai.org
jodhpur@icwai.org
kanpur@icwai.org
kota@icwai.org
lucknow@icwai.org
ludhiana@icwai.org
mankapur@icwai.org
nayanangal@icwai.org
noida@icwai.org
patiala@icwai.org
jammu@icwai.org
udaipur@icwai.org
dubai@icwai.org
nepal@icwai.org
oman@icwai.org
zambia@icwai.org
tanzania@icwai.org
botswana@icwai.org
south_orissa@icwai.org
the management accountant, February, 2009

EMPLOYEE IDS
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40
41
42
43

Shri Sudhir Mukund Galande


Shri Rabindra Nath Pal
Mrs. Chandana Bose
Shri J. P. Singh
Shri Sanjib Ratan Saha
Shri Kaushik Banerjee
Shri D. Chandru
Shri S. C. Gupta
Smt Anita Singh
Shri Pramod Somnathe
Shri Vikas Saraf
Shri Vikash Shukla
Shri Sanjoy Mukherjee
Anamika Mukherjee
Shri Shymalendu Nag
Shri Antarjami Jena
Shri S. K. Sharma
Shri Arunava Gangopadhyay
Smt. Sucharita Chakraborty
Shri Kushal Sen Gupta
Ms. Arundhati Basu
Shri Saurabh Sarkar
Shri Ashim Kumar Gangopadhyay
Shri N. Mohan Swamy
Shri Mridul Kanti Saha
Shri Swapan Kumar Mazumdar
Shri Swapan Bhattacharyya
Shri Prabir Banerjee
Shri Arpan Banerjee
Shri Tarak Nath Mukherjee
Shri Pradip Kumar Datta
Shri Dulal Chandra Mondal
Shri Gautam Basu
Shri Gobinda Mukherjee
Shri Subhasis Bhattacharyya
Shri Aloke Mukherjee
Shri Samir Mukherjee
Shri Sanjoy Roy Chowdhury
Shri Tarun Kumar
Shri Sanjeev Goel
Shri Chiranjib Das
Ms. Indu Sharma
Shri Ashish Tiwari

C.E.O.
Sr. Director
Sr. Director
Director
Jt. Director
Jt. Secretary
Jt. Director
Jt. Director
Jt. Director
Jt. Director
Jt. Director
Jt. Director
Dy. Director
Dy. Director
Dy. Director
Dy. Director
Dy. Director
Asstt. Director
Asstt. Director
Asstt. Director
Asstt. Director
Asstt. Director
Asstt. Director (S)
Asstt. Director (S)
Asstt. Director (S)
Asstt. Director (S)
Asstt. Director (S)
Asstt. Director (S)
Asstt. Director (S)
Asstt. Director (S)
Asstt. Director (S)
Asstt. Director (S)
Asstt. Director (S)
Asstt. Director (S)
Asstt. Director (S)
Asstt. Director (S)
Asstt. Director (S)
Asstt. Director (S)
Asstt. Director
Asstt. Director
Asstt. Director
Asstt. Director
Asstt. Director

the management accountant, February, 2009

C.E.O.
Fin. & Admn.
Examination
Technical
Fin. & Admn.
Membership
CEP
Fin. & Admn.
IT
CAT
T&P
PR
Examination
Research & Journal
Fin. & Admn.
Fin. & Admn.
Technical
Examination
Studies
Fin. & Admn.
Research & Journal
IT
Fin. & Admn.
Studies
Examination
C.E.P.
Examination
Examination
Research & Journal
Membership
Fin. & Admn.
Research & Journal
Studies
Fin. & Admn.
Studies
Membership
Examination
Fin. & Admn.
Technical
CEP
Studies
Fin. & Admn.
IT

ceo@icwai.org
fna.rnpal@icwai.org
exam.cb@icwai.org
technical.jps@icwai.org
fna.saha@icwai.org
membership.kb@icwai.org
cep.chandru@icwai.org
admin.gupta@icwai.org
it.anita@icwai.org
cat.somnathe@icwai.org
tnp.saraf@icwai.org
pr.shukla@icwai.org
exam.sanjoy@icwai.org
rnj.anamika@icwai.org
fna.nag@icwai.org
fna.jena@icwai.org
technical.sudhir@icwai.org
exam.arunava@icwai.org
studies.sucharita@icwai.org
fna.kushal@icwai.org
rnj.abasu@icwai.org
it.saurabh@icwai.org
fna.ashim@icwai.org
studies.swamy@icwai.org
exam.saha@icwai.org
cep.swapan@icwai.org
exam.swapan@icwai.org
exam.prabir@icwai.org
rnj.arpan@icwai.org
membership.taraknath@icwai.org
fna.datta@icwai.org
rnj.mondal@icwai.org
studies.gautam@icwai.org
fna.gobinda@icwai.org
studies.subhasis@icwai.org
membership.aloke@icwai.org
exam.samir@icwai.org
fna.sanioy@icwai.org
technical.tarun@icwai.org
cep.sanieev@icwai.org
studies.chiranjib@icwai.org
fna.indu@icwai.org
it.ashish@icwai.org

167

Regional Conference at Chandigarh


Management Accounting for Corporate Competitiveness
A two days conference organized by NIRC of ICWAI in association with Chandigarh-Panchkula Chapter was
inaugurated by Sh. Pawan Bansal, Union Minister for State for Finance and Sh. Randeep Singh Surjewala.
On the occasion, Mr. Pawan Bansal said our growth rate is at 7% which is good sign for any economy. Professionals
like Cost and Management Accounts a have played a vital role in it.
Addressing the conference, Mr. Surjewala said a fresh approach to corporate and accountability was the order of the
day. He further added that to sustain and achieve competitive advantage, customer focus was the main mantra.
On the eve of the conference, President of ICWAI Mr. Kunal Banerjee announced a new Accounting Technician
Course for undergraduates students launched by The Institute of Cost and Works Accountants of India at a Press
Conference in Chandigarh. He told that the said course is designed to fill the gap of junior level accountants in the
corporate sector and the duration of the course is one year. Mr. Banerjee informed the press that institute had signed
an agreement for mutual recogition of ICWAI courses with a leading institute in U.K.
While addressing the conference Mr. Banerjee, said in developed countries, innovation in applying information and
communication technologies to trade was an undisputed drivers of competitiveness.
During two days conference, delegates and participants discussed about :
The World Economic developments and impact on Indian Corporate Sector,
Management Accountancy for Business Strategy and Value Creation
Enterprise Risk Management for Corporate
Currency Futures and Derivatives in India
International Financial Reporting Standard
ERP-Corporate Management Solutions
New Companies Bill-2008
LLP-Opportunities and Risk
Prof. Shashi Kant, an Economist, felt that the main challenge facing firms today was how to take advantage of new
resources and market while dealing with intense and growing global competition.
Mr. Vimal Aggarwal, a practicing Cost Accountant, explained how Intellectual Property can be use full for value
creation of the product and the business house. He mentioned that the value of Plant and Machinery may note be in
crores but your product reputation may run into billions. He gave the examples of SURF, DALDA etc. which has
gained the value in the market.
Mr. Balwinder Singh, CCM-ICWAI, elaborate on Convergence to International Financial Reporting Standards (IFRS).
He explained that it is much talked about topic in the accounting world today. Many nations have shifted over to IFRS,
while many others are in process of converging their national GAAPs to IFRS. Ms. Swati from YES Bank elaborated
the Currency and Future Derivatives and other related products available in market and their prospective in Indian
market. Speakers also discussed the New Companies Bills-2008 and Limited Liability Partnership Act. and review the
challenges and the new business formations in light of the said acts.
At the valedictory session, Sh. Avtar Singh, Chairman, Sri Sukhmani Group of Institutions, Derabassi was the chief
guest. Mr. Singh praised the efforts of NIRC and Chandigarh-Pkl. Chapter for providing such a platform where
professional from various fields came together and discuss the recent changes took place in the world. He also
narrated the role of Cost Accountants in the industry at large.
At the end Mr. Rakesh Bhalla, Secretary and Treasure, NIRC presented Vote of Thanks.

168

the management accountant, February, 2009

Anda mungkin juga menyukai