Sebi has recently revised Clause 41 of the Equity Listing Agreement, which governs the submission of quarterly results to stock exchanges. The revision aims to rationalise formats and the submission process. The revised Clause 41 is applicable in respect of accounting periods commencing on or after July 1, 2007.
First, the revised Clause 41 requires that while placing the financial results before the board, the CEO and the CFO shall certify that the financial results do not contain any false or misleading statements or figures and do not omit any material fact which may make the statements or figures misleading. This requirement is similar to that in Clause 49, which embodies the corporate governance code. The revised Clause 41 further requires that the financial reports should be approved by the board or a committee (other than the audit committee) of the board, which shall consist of at least one-third of directors and shall include the managing director and at least one independent director.
When the quarterly financial results are approved by the committee, they shall be placed before the board at the next meeting. These modifications will enhance the accountability of the CEO, the CFO and the audit committee. They also reinforce the underlying principles that approval of the financial results, based on the recommendation of the audit committee, is a routine activity of the board.
Many board members feel that way. In fact, the board is required to apply its collective wisdom in approving financial results or in considering the accounting policy or the audit report. The practice of working through committees aims to improve the effectiveness of the functioning of the board and not to absolve the board of its responsibilities.
Another important revision is regarding explanation as to variations in unaudited and audited results. The revised Clause 41 requires that where there is a variation between the unaudited quarterly or year-to-date financial results and the results amended pursuant to limited review for the same period and the variation in net profit or net loss after tax is in excess of 10 per cent or Rs 10 lakh or higher, the company shall explain the reasons for variations.
Similarly, a company has to explain a variation of more than 10 per cent or Rs 10 lakh, which ever is higher, in exceptional or extraordinary items. Revised Clause 41 requires disclosure of exceptional and extraordinary items. Earlier, a company was required to explain variation of 20 per cent or more in respect of any item given in the format prescribed by Sebi for the presentation of quarterly results. The revision is sensible. But the limit of Rs 10 lakh may create hardship for big companies. Materiality should be the governing principle. Therefore, the limit of Rs 10 lakh may not be warranted. Perhaps, we are yet to recognise that many of our listed companies have grown in size and the rate of growth is faster than earlier.
The revised Clause 41 specifically stipulates that the quarterly and year-to-date results are to be prepared and presented in accordance with the recognition and measurement principles laid down in Accounting Standard (AS)-25, Interim financial Reporting. AS-25 stipulates the accounting principles and methods for the preparation and presentation of interim financial reports. AS-25 requires the preparation and presentation of an interim financial report containing at least a set of condensed financial statements. Therefore, a quarterly financial report that a company presents in accordance with the requirements of Clause 41 is not an interim financial report. Therefore, only that part of AS-25 which deals with recognition and measurement principles is applicable.
Preparation and presentation of interim financial reports has certain inherent difficulties. Revenues of some businesses fluctuate widely among interim periods because of seasonal factors; in some businesses, heavy fixed costs incurred in one interim period benefit more than one interim period; costs and expenses related to a full year’s activities are incurred at infrequent intervals during the year; and the limited time available to develop complete information required to estimate assets, liabilities, income and expenses.
There are two distinct views of interim reporting: “integral” and “discrete”. According to the integral view, each interim period is primarily an integral part of the annual period. Under this view, deferrals, accruals and estimations at the end of each interim period are affected by judgments made at the interim date with reference to the results of operations for the remainder of the annual period.
According to the discrete view, each interim period is a basic accounting period. Under this view, the results of operations for each interim period should be determined in essentially the same manner as if the interim period were an annual accounting period. Accounting Standard (AS)-25 has adopted the discrete view.
An enterprise estimates the amount at which an asset, liability, income or expense is to be recognised in financial statements based on information available, until the financial statements are approved by the Board of Directors. The same principle is applied in the preparation and presentation of interim financial reports. Estimates might change in the subsequent periods based on new information. Amounts of income and expenses reported in the current interim period reflect any changes in amounts reported in prior interim periods of the financial year. The amount and nature of any significant change in estimates should be disclosed.
Revenues that are received seasonally or occasionally within a financial year should not be anticipated or deferred as of an interim date if anticipation or deferral would not be appropriate at the end of the enterprise’s financial year.
Costs that are incurred unevenly during an enterprise’s financial year should be anticipated or deferred for interim reporting purposes only if it is also appropriate to anticipate or defer that type of cost at the end of the financial year. A company should estimate provisions in respect of gratuity and other defined benefit schemes for an interim period on a year-to-date basis by using the actuarially determined rates at the end of the prior financial year.
However, it should not anticipate major planned periodic maintenance and overhaul for interim reporting purposes unless an event has caused the enterprise to have a present obligation.
Interim period income-tax expense is accrued using the tax rate that would be applicable to expected total annual earnings, that is, the average annual effective income-tax rate applied to the pre-tax income of the interim period.
The estimated average annual income-tax rate would reflect the tax rate structure expected to be applicable to the full year’s earnings including fully or substantively enacted changes in the income-tax rates scheduled to take effect later in the financial year. The estimated average income-tax rate is re-estimated on a year-to-date basis.
A company considers the effect of the tax loss carry forward to determine the estimated average annual effective tax rate if the criteria for recognition of a deferred tax asset are met at the end of the interim reporting period.
A company applies the same impairment tests, recognition, and reversal criteria at an interim date as it would at the end of its financial year. An enterprise assesses the indications of significant impairment since the end of the most recent financial year to determine whether a detailed impairment calculation is needed.
The revision of Clause 41 is definitely a step forward. Let us hope that some companies take it further and present a set of condensed financial statements at least on a half-yearly basis.
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