Soon, net profit will be 3 numbers, not 1

MUMBAI: If all goes according to plan, current accountancy books would be consigned to pages in history soon.

In a report on Saturday, the Wall Street Journal said global accounting standards-setting bodies such as the Financial Accounting and Standards Board (FASB) of the US and the International Accounting Standards Board (IASB) based in London are planning to do away with the single net profit figure.

Indian accounting standards are more or less drawn from IASB tomes.

What’s the problem with a single net profit figure?

It leaves a lot of room for manipulation. With investors largely concentrating on this number, companies have an incentive to tweak it.

A case in point is Enron, the bust US energy firm, which used creative accounting to portray itself as an extremely profitable enterprise when its main businesses were far from being so.

Enron got away for a while because investors concentrated on what later became an accursed number - its net profit, which displayed magical levitation powers.

In a statement on March 20, 2007, FASB said a financial statement should help those using it understand the past operating, financing and other activities that caused an entity’s financial position to change, and the components of those changes.

Given this, it has proposed to divide a financial statement into operating, investing and financing activities and come up with a net profit and expense figure for each activity.

Manipulation becomes very difficult using such a format, it is felt.

A Big Four chartered accountant based in Mumbai, who cannot be quoted due to office regulations, said in the Indian context, a lot of small companies declare attractive unaudited quarterly profits and then publish their results in the business media, hoping that investors will buy the stock.

“If this change is brought about, we will see far less manipulation,” he said.

The balance sheet will also be trifurcated on the basis of operating, investing and financing activities.

This format will run vertically vis-a-vis the current format, which has assets and liabilities placed against each other.

The companies will also have to explain why a particular entry falls under a particular segment.

In this effort the FASB has involved other accounting boards across Asia and Europe, as well, to get some uniformity in the way financial reporting happens across the globe.

“Over time, accounting has evolved into a single language spoken in different dialects. In the end, it all comes down to four items — income, expenditure, assets and liabilities. Each country has found its own way to report on these,” said Sandeep Shanbhag, director, A N Shanbhag NR Group, a financial consultancy.

As global trade integrates, uniformity in the way numbers are reported across the globe becomes increasingly imperative.

Currently Indian companies follow the Accounting Standards and Guidance Notes of the Institute of Chartered Accountants of India, a statutory body established under an Act of the Parliament.

But many, especially those having an international presence, also make their financial statements as per US GAAP (Generally Accepted Accounting Principles) norms.

Unsurprisingly, the results differ.

Shanbhag said standardisation is critical to achieve the ultimate objective — of presenting a true and fair picture of the business that doesn’t boggle the investor. “As far as making efforts towards this goal is concerned, more is less.”