New Accounting Norms to Increase Liabilities of Cos

New Accounting Norms to Increase Liabilities of Cos

(Source: The Economic Times, June 09 2012)

As per the new norms long-term loans will now show as a current liability on cos books

Indian companies, grappling with slowing business environment and deferment of projects, will now have to contend with another challenge from a recent change in accounting principles that will increase their current liabilities and ability to borrow.

The changes approved by the ministry of corporate affairs have, however, been cushioned with a qualification from the Institute of Chartered Accountants of India, the nodal body to recommend accounting changes, putting the onus on lenders.

The ministry issued the revised Schedule VI to Companies Act, through notification (No. S.O. 447 (E)) by laying down a new format for presentation of financial statements.

The earlier Schedule VI has been followed for more than 50 years. The new requirement to classify all assets and liabilities into current and non-current categories, says liabilities expected to be realised or settled within 12 months from the balance sheet should be classified as current. This will now show long-term loans — repayable within 12 months from the balance sheet — as a current liability.

Such a move will impact key financial ratios such as working capital, current asset and debt equity ratios, which in turn will have an implication on other terms of the loan, including interest rate or repayment terms.

Indian companies have been unable to service their debts due to the slowdown in economic environment and high interest rates. During the March quarter, for companies in the BSE 500 index, the interest coverage ratio — the ability to pay interest on loans — is at 4.9 times, which is the lowest since the liquidity crisis of 2008.

But this classification of long-term loans as a current liability has been provided relief through a guidance note issued by the ICAI that asks lenders to first recall these loans in the event of a breach. Typically, loan agreements in India include a variety of covenants, which if breached will give the lender the right to recall the loan. ICAI’s guidance note has clarified that the loan becomes current only if the lender recalls the debt.

“Banks in India generally do not recall loans on concerns that they will have to show this as an NPA (non-performing asset) on their books,” said KPMG partner and global head of accounting advisory services Jamil Khatri. “Taking on a default in a covenant is generally added as a matter of abundant caution and banks generally do not demand repayment of loans on minor defaults of debt covenants.” A Crisil report pointed out that with corporate defaults rising sharply, the current fiscal year will see Indian banks restructure about . 1 trillion worth of loans, an increase of 54% over last year. The ICAI guidance note also provides relief by saying that if there is a minor breach such as a default in the filing of quarterly information and the lender has not recalled the loan as on the date of approval of the financial statements, the loan should continue to be shown as non-current.

Ernst & Young partner Dolphy D’Souza said the institute has gone a step further and included even large defaults. “In the guidance note they had clarified that minor breaches on the balance sheet date does not lead to classification of the loan as current unless the bankers have actually called the loan,” he added.

Numbers Game

• The classification of long-term loans as a current liability has been provided relief through a guidance note issued by ICAI that asks lenders to first recall these loans in the event of a breach

• The current fiscal year will see Indian banks restructure about . 1 trillion worth of loans, according to a Crisil report