journal[1]

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CONTENTSPresident’s Message

From the Editor

Fair Value Accounting in Sri Lanka: Auditors’ Perception of Usefulness and Awareness, and Challenges Faced by Audit Profession

By Jayanthi Kumarasiri and Abeyratna Gunasekarage

World Economic Recession and Sri LankaBy R.A. Jayaweera

Churchillian view of The Economy and the IMF ProgramAn Interview with Dr Koshy Mathai, IMF Representative in Sri Lanka

Reminiscence of an Articled Clerk in the Early Days of the InstituteBy Rex Olegasegarem

ICASL Events

Quarterly Technical Update

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Council Members 2010/2011

Mr. D T S H Mudalige - PresidentMr. Sujeewa Rajapakse - Vice PresidentMr. Ganaka AmarasingheMr. T Dharmarajah Mr. W N I C FernandoMr. Channa GunasekeraMr. Arjuna HerathMr. J M U B Jayasekera Mr. S Manoharan Mr. Jagath Chandana PereraMr. Shan Shanmuganathan Mr. S Swarnajothy Prof. M W Wickremarachchi Mr. Lasantha Wickremasinghe Mr. Velupillai KanagasabapthyMs. Coralie Pietersz

Journal Committee Chairman - Channa S. ManoharanEditor/Secretary –Sunil KarunanayakeA R RasaihA N FernandoPurajitha TaldenaPriyanjith FernandoRanganath AbeykongeKeerthi HandapangodaDammika RajapakseI MohammedRenuka LiyanaratneDinuk HettiarachchiA P S M Sanjeewa ThusharaMohamed Rasheed M RashmiK H Saman Kumara

AdministrationChief Executive Officer/Secretary - Aruna Alwis

Director Finance - Vasani Manodara

Director Examinations - W.W. Wijeratne

Project Director/Director Members/CPD - Sunil Karunanayake

Chief Administration Officer - Udeni Munasinghe

Chief Information Officer - G. Wickremasinghe

Head of Technical - Chamila Cooray

Head of Education and Training - Nilushi Dissanayake

Brand Communication Manager - Lasantha Amarakoon

Manager Student Services - Sujeewa Munidasa

Manager Business School - Damayanthi Fernando

Manager Multimedia English Language Centre - Achala Kodikara

Manager Studies - Kanchana Gunasekera

Manager IT Training - Nilmini Jayasooriya

Manager Technical - Subashini Withanachchi

Manager Technical - Upendra Wijesinghe

Manager Technical - Nadeeshani Dissanayake

Manager Quality Assurance - Kamal Saseedaran

Manager CPD and Taxation - Priyadarshini Dharmasena

Manager Training - Nimanthi Gamage

Examinations Consultant - K.L. Perera

A brief outline of The Institute of Chartered Accountants of Sri Lanka

The Institute of Chartered Accoun-tants of Sri Lanka is the national professional accounting body of Sri Lanka established by an Act of Parliament, No. 23 of 1959. The Council of the Institute is responsible for the administration and management of the Institute. The Council also conducts qualify-ing examinations, supervises and regulates student education and training, secures the maintenance of professional standards among members and the advancement of the profession.

The Institute is a member of the International Federation of Accountants (IFAC) and the International Accounting Standards Committee (IASC). It is also a member of the Confederation of Asian and Pacific Accountants (CAPA) and a founder of the South Asian Federation of Accountants (SAFA).

The Institute is the sole authority for setting standards in auditing and accounting in Sri Lanka and the application of such standards is mandatory for business enterprises specified in the schedule in the Sri Lanka Accounting and Auditing Standards Act No. 15 of 1995.

The Official Publication of The Institute of Chartered Accountants of Sri Lanka. Established 1959 Volume 45

THE CHARTERED ACCOUNTANT

The Opinions, views and statements published in this Journal are those of the respective authors/contributors. The Institute of Chartered Accountants of Sri Lanka is neither responsible nor does it necessarily concur with the author/contributor unless otherwise stated.

Copyright © 2009 by The Institute of Chartered Accountants of Sri Lanka.

Reproduction in whole or part without the Institute’s (or other copyright holder’s) prior written permission, is strictly prohibited.

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Our Institute proudly and fittingly celebrated its golden jubilee last year. Today we have emerged as the premier national accounting body in Sri Lanka catering to a wider student population while our membership has grown to 4000 with nearly twenty five percent of them serving overseas. This is a tribute to our founders who worked with determination and courage to build up the ICASL to its present eminent status. We cannot be complacent and sit on our laurels. Today we live in a highly-networked global village with vast changes taking place among our midst. In Sri Lanka, it’s an era of great resurgence after ending a 30-year conflict that stifled the economic growth and general well-being. The economy is now poised to take off with a projected growth of 7% offering many opportunities for economic development. As a responsible professional organization we must look to the future.

We have embarked on our strategy, “Need for Change”, setting a direction for ICASL and the Chartered Accountants to follow at a time of great change in the accounting profession. By taking account of this change and anticipating what may happen over the coming years, we have sought to ‘future-proof’ our objectives for action. This strategy aims to mark out the Chartered Accountant as the professional of the highest standards and skills.

The Challenge Of Change

Globally, we expect the demand for accountants to continue to grow. Compliance requirements are rising and international business is becoming increasingly complex. The ‘internationalization’ of business means that the mastery of international standards in accounting and auditing, ethics and accounting education will be crucial. The expertise of Chartered Accountants, as globally-established and well- regarded professionals, will be sought in more markets than ever before.

The education of accountants will change. There will be a greater push towards specialization and lifelong learning. Corporate social responsibility and the reporting of environmental issues will be a stronger focus for business everywhere – this needs to be reflected in the lifelong education delivery for Chartered Accountants.

Shaping debate wherever we have members is fundamental to how we are perceived as an Institute. Given that CAs operate in many countries, our ideas and thought leadership must be intelligent, valuable and capable of influencing change in the business world.

At ICASL, we believe in competition and co-operation. We will work with other bodies in the public interest. ICASL will continue as a strong, independent Institute, whilst recognizing its global membership, its

excellence in training and high standards.

Meeting The Challenge

Our objectives aim to ensure that the focus on the individual CA in a global business environment can be achieved. Keeping CAs ‘Clearly Ahead’ is the fundamental goal of the council, staff and resources of ICASL.

Facing new challenges requires new approaches. Our examinations, education and training will continue to embrace the needs of modern business, as well as examine the introduction of technology to help employers and students. ICASL will be innovative in its thought leadership as never before. The services that we provide to members will be delivered in new ways, with more relevance to their individual needs. In these core functions of a professional body, we aim to provide a benchmark of quality for others to follow.

We have worked hard to create themes that are achievable and measurable to take the Institute forward. The mission is simple – to enhance the global standing of the Chartered Accountant. By sticking to this strategy, that will be achieved. We recognize our membership as our utmost strength no doubt. I together with my council would welcome your thoughts in this enduring journey into the 51st year of the ICASL.

Sujeewa MudaligePresident

President’s Message

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It is our pleasure and privilege to welcome the new president Sujeewa Mudalige and the new council that took office in early 2010. While we record our appreciation to the outgoing Chairman Sujeewa Rajapakse who served us four fruitful years we look forward with enthusiasm to the new Chairman Channa Manoharan who is bubbling with ideas to give a new look to the “Chartered Accountant’’ now on to its 47th year. ICASL celebrated the Golden Jubilee with a series of events last year and the president Sujeewa Mudalige has great plans to take ICASL to greater heights during his regime.

While we reach you with the first quarter Journal somewhat behind time we are happy to deliver it with a complete new look and few more features. Given the heightened interest on the concept of “Fair Value Accounting”

C h a r t e r e d A c c o u n t a n t A b e y r a t n a Gunasekarage with Jayanthi Kumarasiri who are academics resident in Australia present their experience in Sri Lanka titled “Fair Value Accounting in Sri Lanka: Auditors’ Perception of Usefulness and Awareness and Challenges Faced by Audit Profession”. Chartered Accountant R A Jayaweera presents his views on effects closer home in his presentation “World Economic Recession and Sri Lanka”. Sri Lanka too faced many economic hardships following the global economic fallout resulting in a major decline in foreign reserves thus adversely affecting country’s external financing; it was in this background that the IMF came up with a standby agreement that aroused public interest. An interview given by Koshy Mathai, IMF resident representative in Sri Lanka styled on the Churchillian model

based on the “World War 11” consequent to his first public appearance in Sri Lanka gives a good insight into the recovery of Sri Lankan economy. Rex Olegasegarem, a member of the founder’s batch of the ICASL now resident in Australia presents his visit down the memory lane inclusive of the happy-go-lucky Ar t i c ledsh ip days.

We were compelled to curtail the articles to make way for the Quarterly Technical Update published by the Technical and Research division that will be a regular feature in the future.

Sunil Karunanayake

From the Editor

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By Jayanthi Kumarasiri and Abeyratna Gunasekarage

Fair Value Accounting in Sri Lanka:

Auditors’ Perception of Usefulnessand Awareness, and Challenges Faced

by Audit Profession

the main findings of a questionnaire survey which investigated Sri Lankan auditors’ perceptions of fair value measures.

What is Fair Value Accounting?FVA is an accounting practice which reports assets and liabilities at their estimated current value (Ramanna, 2008). In FAS 157: Fair Value Measurements, the term ‘Fair Value’ is defined as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date” (FAS 157, Paragraph 5). The estimation of fair value is particularly problematic for assets and liabilities that do not have active markets and that consequently require a considerable level of professional judgment (Ramanna and Watts, 2007; Ernst & Young, 2005). It is argued that auditors face a major challenge with respect to providing an assurance of the appropriateness of fair value measures, as most of the current auditors are not q u a l i f i e d or sufficiently competent to judge or evaluate the techniques and valuation processes used in arriving fair value measures (Roger et al., 2006).

Fair Value Accounting in Sri Lanka

In general, Sri Lankan accounting standards and the accounting

Introduction

Fair Value Accounting (FVA) has been an important topic of debate in the accounting world among standard setters, practitioners, government bodies and academics. The main reason for this increased interest is the introduction of many accounting standards by the International Accounting Standard Board (IASB) and the Financial Accounting Standard Board (FASB) which either recommends or mandates the use of fair value measures in financial reporting. The preference for fair value accounting over the

historical cost accounting by the FASB and the IASB comes from the belief that financial statements based on fair values can provide more relevant, comparable and faithful representation of assets and liabilities (Barth, 2007). Very recently, FVA grabbed the attention of the accounting world

for a different reason. FVA has been blamed for exacerbating the recent global financial crisis which has led to the collapse of many leading financial institutions around the world (see, for example, Anonymous, 2008; Leone, 2008). However, whether FVA played a contributing role in current credit crisis is still an unresolved issue.

The increased use of fair value measures in financial reporting brings considerable challenges to preparers of financial statements, auditors and setters of accounting and auditing standards. The Institute of Chartered Accountants

of Sri Lanka (ICASL) intends to promote the application of FVA in Sri Lanka. This intention was highlighted at the 2007 South Asian Federation of Accountants (SAFA) conference. It is therefore important to ascertain the views of Sri Lankan audit professionals about fair value measures. In this paper, we present

Auditing financial statements based on fair value measures has been a challenging task for auditors in developed countries which have been using FVA for many years (see, for evidence, Roger et al. 2006; Ramanna, 2008; Ramanna and Watts, 2007). It is interesting to know whether the Sri Lankan auditors share similar perceptions with respect to their understanding of FVA concepts and auditing financial statements based on fair values; the current study intends to address this question.

Jayanthi Kumarasiri [BSc. Bus. Adm. (USJP, Sri Lanka); BCom Hons. Acct. & Fin. (Canterbury, New Zealand)] is an Associate

Lecturer at the Department of Accounting and Finance of the Faculty of Business and

Enterprise, Swinburne University of Technology, Australia.

Abeyratna Gunasekarage [BSc Bus. Adm. (USJP, Sri Lanka); MAcc (Dundee, UK); PhD

(Dundee, UK), ACA (Sri Lanka)] is a Senior Lecturer at the Department of Accounting

and Finance, Monash University, Australia.

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framework is mainly based on historical cost principles: however, an increase in the usage of fair value accounting is visible with the introduction of several fair value-related accounting standards during the last decade. For example, standards such as Business Combination (SLAS 25), Investment Property (SLAS 40), Impairment of Assets (SLAS 41), Financial Instruments: Presentation (SLAS 44) and Financial Instruments: Recognition & Measurement (SLAS 45), which are mainly based on the FVA principles, encourage preparers of financial statements to use fair value measures whenever possible.

As far as auditing standards are concerned, Sri Lanka does not have a specific auditing standard relating to auditing of financial statements which are based on fair values. The ICASL follows SLAS 18: Auditing of Accounting Estimates which is in compliance with International Standard of Auditing 540: Auditing Accounting Estimates. The importance of transforming historical cost accounting to FVA has been highlighted by the President of ICASL at the 2007 SAFA conference. He explained the initiatives taken by the ICASL such as the syllabus revisions and the adoption of new FVA standards to facilitate the acceptance of fair value measures. A partner

from KPMG Sri Lanka expressed similar views when he stressed the importance of FVA and demonstrated the readiness of the accounting profession to accept the paradigm shift to FVA (The Sunday Times, Sept. 2, 2007). The Chairman of the Auditing Standards Committee of the ICASL revealed to the authors that the Institute was in the process of developing an auditing standard, which is similar to ISA 545: Auditing Fair Value Measurements and Disclosures, by the end of 2008.

Auditing financial statements based on fair value measures has been a challenging task for auditors in developed countries which have been using FVA for many years (see, for evidence, Roger et al. 2006; Ramanna, 2008; Ramanna and Watts, 2007). It is interesting to know whether the Sri Lankan auditors share similar perceptions with respect to their understanding of FVA concepts and auditing financial statements based on fair values; the current study intends to address this question.

Structure of the Study

The study was based on a questionnaire survey. The questions included in the survey were structured to gather information

on auditor’s (i) perception of the usefulness of fair value measures, (ii) awareness about fair value accounting and auditing standards, (iii) views about the challenges faced with the increased use of fair value accounting in financial reporting, and (iv) suggestions to overcome such challenges. The questions were designed on the basis of issues raised by the academic and professional literature as well as the exposure drafts and discussion papers issued by the IASB and FASB on fair value measures. These closed-ended questions were structured with a five-point Likert scale such as ‘strongly disagree’ (1), ‘disagree’ (2), ‘neither agree nor disagree’ (3), ‘agree’ (4) and ‘strongly agree’ (5) and the participants were asked to indicate their response by circling only one scale:

The questionnaire was distributed among 160 senior auditors (i.e. audit partners and audit managers) in 18 leading Chartered Accountancy firms operating in Colombo. The final sample consisted with 81 questionnaires, representing a response rate of 50.63 percent, out of which 33 (40.7 percent) were from Big 4 accounting firms while the remaining 48 (59.3 percent) were from Non-Big 4 firms. The participants had an average of 6.7 years of experience in the profession.

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Auditors’ Perception and Awareness of FVA

Three main questions were asked in order to examine whether the auditors believed that fair value based financial reports would be more useful in Sri Lanka compared to those based on historical cost accounting. The relevant questions and the mean scores generated for them are reported in Table 1.

The Sri Lankan auditors surveyed in this study believed that fair value accounting was a better basis for financial reporting, compared with historical cost accounting. The statement relevant to this aspect generated a mean value of 4.06. They were also in agreement with the view that financial statements based on FVA reduced the information gap between what users expect from financial statements and what they actually receive from them; the mean score for this statement was 3.73. They believed that financial statements based on fair value measures were more useful to users of such reports than those based on historical cost accounting; the relevant statement was given a mean score of 3.95. Two of the above three mean scores are either above or close to 4 (‘agree’ scale) while the other is above 3.5 indicating that the respondents agreed with the stated statements. More importantly, these mean values deviated from 3 (i.e. neutral position) in a statistically significant fashion.

Even though the auditors agreed that FVA was a better basis for financial reporting, they did not demonstrate a strong level of awareness about accounting and auditing standards relating to this issue. The statements relevant to this aspect and their mean scores are presented in Table 2.

The auditors did not seem to have an adequate awareness on fair value accounting standards/auditing standards at either the international or local level. The statements which tested their awareness of FAS 157 and ISA 545 generated mean scores of 2.54 and 2.82 respectively. The first mean is significantly lower than 3 thereby leaning towards disagreement with the statement while the other is statistically indistinguishable from 3 indicating an indifferent position. A similar response was documented for the respondents’ awareness of SLAS 45. The relevant statement generated a mean score of 3.04 which is also insignificantly

Statement

Fair value accounting is a better basis for financial reporting than historical cost accounting for financial statement users

Financial statements based on fair value accounting reduce the information gap between what users expect and what they actually receive from financial statements.

Financial statements prepared using fair value measurements are more useful to users of such reports than those prepared using historical cost accounting.

Mean Score

4.06**

3.73**

3.95**

Note: An *(**) indicates that, on the basis of one sample t-test, the relevant mean value is statistically significantly different from 3 (i.e. midpoint) at the 5 percent (1 percent) level.

Statement

Auditors have a clear understanding of the US Financial Accounting Standards Board’s FAS 157: Fair Value Measurements

Auditors are well aware of the requirements of the new International Standard on Auditing, ISA 545: Auditing Fair Value Measurements and Disclosures

Auditors have a clear understanding of the SLAS 45: Financial Instruments: Recognition and Measurements

Before auditing items measured at fair value, auditors need to gain knowledge about the processes used by the client in arriving at those measurements.

Mean Score

2.54**

2.82

3.04

4.24**


Table 2: Auditors’ Awareness of Fair Value Standards

Table 1: Auditors’ Perception of Usefulness of Fair Value Measures

different from 3. ICASL introduced SLAS 45 in November 2007 and the standard became effective from 1 January 2009. This survey was conducted in April/May 2008 – five to six months after the introduction of the standard but before financial statements had to comply with its requirements. However, the findings of the survey reveal that these auditors do not seem to have gained awareness on this standard during this period. Nevertheless, the Sri Lankan

auditors surveyed in this study believed that gaining competency on fair value measures was important; the relevant statement achieved a mean score of 4.24 which is significantly higher than 3. The auditing standard ISA 545: Auditing Fair Value Measurements and Disclosures emphasises the importance of auditors having a clear understanding about the accounting and technical aspects behind fair value measures. The lack of knowledge on fair value-based accounting and auditing Standards suggests that such

an understanding was lacking at the time of the survey. This finding highlights the necessity of obtaining adequate knowledge about the relevant standards before performing their functions which involves auditing fair value measures. In this respect, professional and academic bodies in Sri Lanka have a responsibility to provide the training necessary for auditors to improve their knowledge about this issue. This is of paramount importance; if

the auditors do not possess the competency to perform their professional duties with confidence, it may have a negative impact on the credibility of the professional opinion that they deliver.

Challenges Identified by Auditors

The survey also attempts to identify challenges faced by auditors in auditing financial statements based on fair value measures. The statements in Table 3 were tested for this purpose.

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Statement

Auditing financial reports based on fair value accounting is more challenging than those based on historical cost accounting

The biggest challenge faced by auditors with fair value measurements is the verifiability of such measurements

Mean Score

4.04**

4.06**

Statement

Techniques used to ascertain fair value measures differ across different industries

Most of the relevant assets and liabilities are not traded on active markets

Fair value measures frequently incorporate estimates of future events and conditions (amounts and time of cash flows, discount rates etc.)

Ascertaining fair value measures is more complex than ascertaining Historical Cost

The assets and liabilities are valued by using managerial assumptions and mathematical models

Ascertaining fair value measures is a time- consuming task

Auditors lack of technical knowledge about fair value measures

Opportunities available to auditors to gain knowledge about fair value measures are limited

Mean Score given by

participants

4.09

4.10

3.94

3.88

3.85

3.74

3.55

3.35

Mean Score generated by Friedman test

5.23

5.21

4.85

4.79

4.68

4.20

3.65

3.37

Mean rank based on

Friedman test

1

2

3

4

5

6

7

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Table 4: Order of Factors Contributing to Challenges

Table 3: Challenges in Auditing Fair Value Measures


Clearly, auditors believed that auditing financial statements based on fair value measures was more challenging to them than auditing those based on historical cost accounting; the statement which captures this opinion received a mean score of 4.04 which is significantly higher than 3 (i.e. indifferent view). They perceived that the verifiability of fair value measures was the biggest challenge that they faced when dealing with FVA by giving this statement a significant mean score of 4.06. These findings are in agreement with the existing international literature which identifies verifiability of fair value measures as the biggest challenge faced by current audit profession (Roger et al. 2006; Fernando, 2007).

In this context an attempt was made to identify the relative importance of a number of factors that might have made verifiability of fair value measures challenging to the respondents. Based on the extant literature, eight factors were developed and the mean scores received for them were subjected to Friedman test in order to rank them from highest challenging factor to lowest challenging factor. The findings of this exercise are reported in Table 4.

The evidence from the Friedman test reveals that the most challenging factor was the ‘usage of different techniques across industries’ (mean score = 4.09; rank = 1) followed by the ‘non-availability of active markets for assets and liabilities’ (mean = 4.10; rank = 2) and ‘the incorporation of estimated future events and conditions’, (mean score = 3.94; rank = 3). The ‘complexity of ascertaining fair value measures’ and the ‘involvement of managerial assumptions and mathematical models’ (with mean scores of 3.88 and 3.85 respectively) were ranked 4th and 5th. These responses of Sri Lankan auditors corroborate

the evidence uncovered in previous studies that were conducted in developed countries; for example, studies by Wilson and Ernst & Young, (2001), Carmichael (2004), Ernst & Young (2004), Roger et al. (2006), Wines et al. (2007) and Hernandez (2004) find that the above factors act as constraints on auditors when auditing fair value-based financial statements.

On the basis of this evidence, it can be argued that the challenges faced by auditors in verifying fair value measures are common to auditors in any country irrespective of whether they are located in a developed or a developing country. In this context, it is appropriate to view auditing fair value measures as a universal challenge faced by auditors.

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Suggestions to Overcome Challenges

Table 5 reports the responses received on the ‘suggestions to overcome challenges in auditing fair value measures’.

Statement

Auditors should be provided with more comprehensive professional training on fair value measurements than they are currently receiving

Until auditors are competent enough to audit financial reports that are based on fair value accounting, they should be provided with necessary expert support

Fair value accounting should be limited to assets and liabilities for which active markets are available

Accounting/auditing professional bodies have the ability to address the challenges faced by auditors in auditing fair value measurements

Mean Score

4.23**

4.01**

3.40*

3.90**

Table 5: Suggestions to Overcome Challenges


The mean scores reported in the above table reveal an overwhelming level of agreement by participants on the suggestions made to overcome perceived challenges. The key suggestions that they overwhelmingly agreed were the ‘need for comprehensive professional training on fair value measurements’ and the ‘need for expert support until they achieve the competency on fair value measures’. Both these statements generated mean scores above 4 which were statistically significantly different from midpoint (i.e. 3). Also, their response to the suggestion that ‘fair value accounting should be limited to assets and liabilities for which active markets are available’ deviated significantly from the neutral view thereby leaning towards agreement. Nevertheless, they placed a strong trust on the ability of professional bodies that they belong to in addressing any challenges faced by the audit profession in auditing fair value measures; the relevant statement generated a mean score of 3.90 which was significantly different from 3 at the 1 percent level.

Conclusion

This study investigated the perceptions of Sri Lankan auditors on fair value measures. According to the results of the study, the participants believed that financial statements based on fair value measures were more useful and informative to users than those prepared on the basis of historical

cost accounting. However, they do not seem to be fully aware of fair value-based accounting/auditing standards at the international and local level. They perceived auditing fair value measures to be a challenging task, mainly due to the

difficulty in verifying such values, and suggested that the provision of adequate professional training on FVA was important to overcome this challenge.

These findings indicate that the Sri Lankan auditors are not in a position to meet the challenge of auditing fair value measures mainly because of their lack of awareness of fair value-based accounting and auditing standards, and the difficulty with verifying fair value measures. In particular, without gaining a thorough awareness on the requirements of relevant accounting and auditing standards and underlying valuation techniques, auditors cannot be expected to exercise due care in the verification of fair value measures. In this context, it is important to provide adequate professional knowledge and training on fair value measures to auditors before expecting them to perform audit functions on fair value-based financial statements. This responsibility lies with the professional and academic institutions in Sri Lanka.

References Anonymous, (2008), “Insurers Say Fair Value Accounting was a ‘Powerful Accelerant’ to Credit Crisis”, Insurance Journal, Available: http://www.insurancejournal.com/news/national/2008/12/31/96675.htm.

Barth, M., (2007), “Standard-setting Measurement Issues and the Relevance of Research”, Accounting

and Business Research, special issue, pp. 7-15.

Carmichael, D., (2004), “The PCAOB and the Social Responsibility of the Independent Auditor”, Accounting Horizons, Vol. 18, pp. 127-133.

Ernst and Young, (2005), “How Fair is Fair Value?”, IFRS stakeholder series.

Fernando, S., (2007), “Auditing Fair Values in Financial Statements”, Press releases, The Institute of Chartered Accountants of Sri Lanka.

Hernandez. F.G., (2004), “Another Step toward Full Fair Value Accounting for Financial Instruments”, Accounting forum, Vol. 28, pp. 167-179.

The Sunday Times, (2007) “Fair Value: a Paradigm Shift”, (2 Sept, 2007). Available; http://sundaytimes.lk/070902/FinancialTimes/ft334.html

Leone, M., (2008), “Europe in lock Step with U.S. Fair Value”, CFO.com Available: http://www.cfo.com/article.cfm/12382799?f=home_featured.

Ramanna, K., (2008), “The Implications of Unverifiable Fair Value Accounting: Evidence from the Political Economy of Goodwill”, Journal of Accounting and Economic, Vol 45, pp.253-281.

Ramanna, K. and Watts, R.L., (2007), “Evidence on the Effect of Unverifiable Fair-value Accounting”, Harvard Business School working paper, No. 08-014.

Roger, D.M., Rich, J.S. and Wilks, T.J., (2006), “Auditing Fair Value Measurements: A Synthesis of Relevant Research”, Accounting Horizons, Vol. 20, pp. 287–303.

Wilson, A. and Ernst & Young, (2001), “Fair Value Measurement: Where the Conflicts lie”, Balance Sheet, Vol. 9, pp. 26-33.

Wines, G., Dagwell, R. and Windsor, C., (2007), “Implications of the IFRS Goodwill Accounting Treatment”, Managerial Auditing Journal, Vol. 22, pp. 862-880.

Acknowledgements: The authors would like to thank the following individuals for the help that they extended during the course of conducting this research project: Mr Richard Fisher for supervising Jayanthi’s honours project; Miss Gayathri Goonathilake for administering the survey and acting as the point of contact for the respondents, Mr Lal Nanayakkara, Mr Sujeewa Rajapakas and Mr Jayamini Kariyawasam for reviewing early drafts of the questionnaire and providing valuable feedback; and Professor David Power for his comments on an earlier draft of this article.

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By R.A. Jayaweera FCASenior Partner, P.E. Mathew & Company, Chartered Accountants

World Economic Recession and Sri Lanka

Economies never developed in a straight line. Downward and upward trends were visible from time to time. There was a great depression during the 1930s. But its effects were not evenly felt throughout the world. Its epicenter was in the United States of America. The world then was not so closely knit as today. Since then there had been economic downturns from time to time. Sri Lankan economic growth rate reduced to a minus value in 2001. Volume of trade in many business enterprises in Sri Lanka declined. Much earlier, during the 1970s an economic crisis was experienced in Sri Lanka. Increased fuel prices were a significant cause for that crisis. The effects of the crisis were minimized by internal economic controls.

The present economic recession is second only to the Great Depression of the 1930s. But it is said that the bottom of the precipice of the falling economy is not discernible as yet. It may even be greater than the Great Depression. Since countries are knitted together firmly today than ever before, not only the countries in the epicentre but even countries in the periphery like ours feel the effects of the tremor of the downfall.

Although we were able to minimize the striking force of the tremor and

Although a few months only have passed since the world economic collapse has begun to receive our attention, it is evident that the world economy had commenced its slowdown at a snail’s pace in 2007 and had been trotting towards a recession. The Dollar, the financial unit of the United States of America, the country considered to be the strongest and the richest in the world commenced its crisis as early as 2004. The Dollar was accepted as the international financial unit. The strength of an economy is reflected in its financial unit. The involvement of a crisis in the world economy did not catch our indicators. Or else the trumpeters, who were in charge of the indicators while watching the situation closely, followed a deaf and blind

attitude. Or else they were not able to comprehend what they saw and heard. They were not sensitive to the changes. Consequently, signals such as, “No danger is

evident. Although vehicles collide there, we will not be affected since we drive on a safer road. We are strong,” were issued. The Sri Lankan public was kept in blissful ignorance.

Is it correct to say that we had to face grave consequences of the world recession as a result of our links with world economy through international trade? Although the statement is correct to some extent it does not reveal the whole truth. We would not have received many of the economic benefits that we have enjoyed had we not been linked with world economy. In addition to and in consequence of the recession imported through our association with the world economy, there

existed inherent characteristics within the Sri Lanka economy too, for a recession. Facts discussed henceforth will bear testimony to this.

The present economic recession is second only to the Great Depression of the 1930s. But it is said that the bottom of the precipice of the falling economy is not discernible as yet. It may even be greater than the Great Depression. Since countries are knitted together firmly today than ever before, not only the countries in the epicentre but even countries in the periphery like ours feel the effects of the tremor of the downfall.

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be resilient we could not and would not detach ourselves completely from the situation and remain unconcerned. No one could expect us to be unconcerned either. In this instance one may recollect the dreadful terrorist bomb attack at Dalada Maligawa where it was claimed that the damage was minimal as the section affected had been a construction of wattle and daub. Fewer inclusion of wherewithal of the modern economy or what is designated as “modern” in the economy might have prevented a full-scale intrusion of the forces of recession into our economy which has resulted in an increased resilience. This theory may stay valid in the future as well. Non-inclusion of “novelties” as such is not backwardness. It is only shedding what is imprudent. Judging what is prudent and what is not in an economy is highly controversial.

Numerous forces are active within an economy of a country. Therefore, it is difficult to come to a compromise as to which is good and which is bad, which is beneficial and which is harmful and which is favourable and which is unfavourable. The market is recognized as the umpire. It is taken for granted that market signals to economic activities are logical and conformity to such signals, results in optimum utilization of resources.

It now appears that charging the market with unlimited powers of decision-making without even a jury is one reason as to why it was unable to control the dreadful forces that led to economic recession by engaging brakes.

Comprehension of the philosophical profile in the analysis of world economic downfall or recession is beneficial for human existence. A person running with an unrestrained speed and falling down fatigued can be a good comparison for the world economic downfall. The man who falls down needs rest. He needs to regain his lost strength. But will he run again with the speed of a rhinoceros? Or will he trot contented. Opinions, advices and lessons given in favour of a contented economic posture were enormous. Documents written and songs sung were vivacious. “Sustainable Deve lopmen t ” , “Env i ronmen t friendly Development”, “You are not the owner but the protector of this Land”, “Resources under your command are a borrowing from the future generations” were some of the titles of these enormous advices. But none of them were self-oriented. They were unobserved preaching. Nobody adhered to them. Therefore a disobedient child had ultimately been caned.

Unlike beyond human control phenomena of the earth, the solar

system or the space further away, all the causes that led to the recession were caused by man and can be managed by man. These causes were created and the outcomes enjoyed by a minority of men. We single them out and call them the First World. Let us call the majority comprising millions who had no direct connection to these causes and resulting outcomes the Second World. The fate of the people of the second world was as much the same as the fate of the passengers in the bus hastily driven, breaking all norms, by the careless driver through the closed railway gate at Yangalmodara. Until the collision brought them disaster some of the passengers might have remained contented and overjoyed about the bus driver’s careless but fast driving thinking that they will reach their destinations well in advance. There may had been others who disagreed and dissatisfied.

The fate faced by the driver of the bus who overestimated capabilities and ignored norms and limits and the fate of its passengers carry many things in common to be compared with the economic recession. What were the economic capabilities that existed and could have been existing? What were the norms of economic activity? What were the limits? How were those norms and limits violated? Why was the social organization not able to observe,

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control and prevent the disastrous behaviour until they reached a point of complete destruction? Were the decisions of the Market umpire wrong? Why were the people appointed to sense and regulate silent? Why weren’t the warning signals lighted before the collapse? What were the whistle-blowers doing all the time? Does all these mean that macroeconomics has to be reinvented?

Within a given timeframe, technical level and available resources, an economy possesses an optimum production possibility. Knowhow and traditions inherited through generations will, to a certain extent, influence in deciding this optimum production possibility. The production possibility of an economy is displayed by its production possibility boundary. An economy, very often, will not attain its highest production capability. It is not possible to do so. The reason being either, the totality of goods and services produced at such optimum possibility level is not to be required for consumption, or an effective total demand for the purchase of that total quantity of goods and services does not exist. Then the market will not issue go-ahead signals to production. Demand is influenced by the income level of and utility of such goods and services to the consumer. Even in the absence of a successful economic demand generated through an increase in income or readjustment of utility, if a pressurized demand is created by some other means for a certain good or service as if by a magical power, the market will issue a go-ahead signal for the production of that good or service. Such signals were in fact issued. It is similar to a command given to activate an anti-aircraft missile system at the mistaken identity of a flock of birds. The market was subjected to a deception of judging the puffed-up consumer as a real economic consumer. The puffed- up consumer had behaved like a juggler. The apparent demand was not consumer economic based. Economic activities were triggered by the command of the market misguided by this boosted demand. The economy started to run at an enormous unrestrained speed of a flying horse. This overheated economy provided the foundation for and fuelled the overconsumption and the premature consumption and vice versa. The ultimate result was a collapse of the exhausted runner of unrestrained speed. When a certain good or service was driven by this pressurized

demand, overconsumption and premature consumption of many other goods and services were also accelerated simultaneously. The prices of all those goods and services went up. All economic activities accelerated one after the other obtained a high speed. All countries one by one were seen joining this glamorous economic drama. The whole world began to dance swaying hands and legs like an audience of a pop musician on stage. Sri Lanka too, of course those Sri Lankans belonging to the first world, were seemed dancing according to this neo-economic rhythm. That’s why it was told at the very outset that the effects of the economic recession were not of a complete imported nature.

Puffed-up consumer and the fast track, unbridled economic dance were fuelled by all sorts of financial instruments and derivatives. Much of those latest financial instruments and derivatives were seen in America and Europe. Financial instruments existed in the world at all times. Examples are a promissory note for a loan, a Deed for mortgaging a land, Treasury Bills, a Share Certificate, a debenture and a cheque. Money too, is a financial instrument. Most of these financial instruments are subjected to some kind of regulation. But certain financial instruments and derivatives sprung during recent years are void of regulation. Expectation was that they will be controlled by the market itself. One such financial instrument is the Credit Card.

Instead of restricting one’s consumption to what he or she can earn today and tomorrow, the credit card enables him or her to consume today the anticipated earnings of the day after tomorrow and the day following it. Purchase of a good or service which is not essential today or that which might be required after income level goes up in some future day is a premature consumption. Purchase of a good or service depending solely on fashion and outward appearance despite that it can be compensated by an already available good or service is overconsumption. Consumption over and above the generally accepted level of consumption of an economy at a given time period is also an overconsumption. But unlike in physics where an objective measurement like, “standard temperature or pressure” is available; there is no methodology in economics to

measure the generally accepted level of consumption. It appears that macroeconomics has not turned yet to this side of the story. There is a possibility of preparing a some kind of a measure using personal income as a parameter. Overconsumption is always extravagant. Extremely high unrea- listic standards compelling too much caution against almost everything is also a root cause for extravagant consumption.

While the irresponsible and indiscriminate use of future earnings for present-day consumption had caused an economic downfall, another crime which was causing a damage many times greater was taking place. That was the misuse of other peoples’ earnings for another’s extravagant consumption and pseudo-prosperity. Although neglecting and belittling one’s own future could be regarded as an economic miscalculation and a delusion, making use of others earnings for one’s consumption was a cheat and a fraud. People who had been forced to intoxication by overconsumption could not witness this fraud. They were deceived by fairy tales like six percent monthly interest for deposits. The people who were puffed up with this income for a short period not knowing that the days of the bonanza were numbered expected to run this endless race of consumerism. And they fall victim to cheat and fraud.

Individuals, who stole other people’s earnings in this manner, lived in America as well. Out of them the ill-famed Bernard Madoff involved in a fraud of about 65 million U.S.Dollars was sentenced in June 2009 and is serving a jail term of one hundred and fifty years in a prison in North Carolina. The Auditors responsible for the certification of his fraudulent statements of account is facing severe charges punishable with more than one hundred years in jail. There were “Sakwithi” and others in Sri Lanka. They cheated the people and escaped. The people cheated themselves and suffered. The wealth robbed from the deceived people was used for overconsumption.

The regulatory bodies responsible for safeguarding the society against such irregularities were asleep. They awoke only after the ringing of the final bell. We have heard the usual explanation for not being able to perform their duty. The hierarchy of the Golden Key Credit Card Company was arrested. Millions of rupees withdrawn by the directors and high officials of the company

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as monthly salaries and other perks were not out of income earned in business. It was robbing income earned by others and deposited with them. The expenditure by some of the high-ups in the company through their individual credit cards exceeded several hundred million rupees. A major part of this expenditure had undoubtedly been utilized for the purchase of foreign property and the maintenance of an extra-luxurious lifestyle which again is consumed abroad. This type of jugglarized pressure in demand created the temporary “prosperity” in the economies of the “developed” and “rich” countries the deception of which made them assumed the unrestrained speed of the flying horse. In the end, those overheated economies as well as the jugglarized consumers all collapsed. A popular saying to fit the times has been introduced into the economic literature. “The best way to rob a bank is to own one”, goes the saying. The collapse of “well-reputed” banks in America and Europe bear testimony. The Golden Key Credit Card Company is our native example. It is now crystal clear that the donation of a house to a poor person selected at random, granting of a scholarship for a poor student, granting of financial assistance to a small businessman appearing over the

television with a heart-breaking story, and spending for publicity of such “meritorious acts” an amount much higher than the amount really spent over the “meritorious acts”, were through plundered money and not through their own earnings. This, in a way, resembles treating guests at somebody else’s wedding.

The damage caused by the persons who had plundered others’ earnings for their businesses was not limited to the amount plundered. The total damage is beyond recognition. They changed the market signals by force. It was like turning the hands of the clock on your own. For instance, they paid salaries several times higher than the normal market salaries to some of their employees. This was changing job market indicators by force. Other businessmen who needed similar services and who had to observe these forcibly altered indicators faced a dilemma. They could not earn such “high returns” to pay these inflated salaries. Paying a lesser salary left the man unhappy. This unhappiness affected the performance and productivity. Similarly, if a person can earn as much as six percent interest per month, he need not work hard. Someone would have assumed that it was wiser to sell his paddy field and deposit the

proceeds in a company which offered an interest of six percent on its deposits monthly. Many other similar occurrences would have taken place. It is because of these multiple impact reactions that an estimation of the loss to economy is difficult.

The other drastic economic distortion occurs when the production cost of a business having plundered money does not include the cost of capital. As the payment of high monthly interest promised to depositors is only a deception and not an actual outgoing from earnings, the capital accumulated was free of charge. There is no fair play and he wins the price war in the market. Reasonable businessmen who lose the race will be pushed out of market leaving it at the mercy of these jugglers. It is a great loss for a country to lose good businessmen. Such loss is immeasurable. This grave economic crime which swept throughout the world causing the economic recession was simultaneously taking place in Sri Lanka. That is why it is incorrect to say that economic recession was imported to Sri Lanka. Its seeds were germinated in Sri Lankan soil as well.

There are a few more sources of free capital the people having access

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to when engaged in economic activities could be detrimental to the rational players in the market. Two such sources are (a) corruption and fraud and (b) donations coming to Non-Governmental Organizations. When the holders of this free capital enter into economic activity they act irrationally. They can pay above the market salaries and price their products below market. The rational economic player could, therefore, be driven out of market. The foul player succeeds not because of efficiency but because of his extra power of free capital. His survival ends with the end of free capital inflow. The economy suffers for ever as rational players were driven out.

Laissez-faire (leaving them alone) is a corner-stone of free market economy. When analyzing reasons leading to the world economic recession, one topic under discussion today is whether some sort of state intervention has become necessary and to what extent such intervention is necessary. Countries who had held the free market system at a very high esteem also have taken this matter into discussion. Because when it reaches the verge of collapse it is the government which has to intervene. The bailout package of the American government to save the collapsed banks exceeded seven hundred billion dollars. It is one hundred times the national government budget of Sri Lanka for the year 2009. It was expected to save the banks by a process of taking over the assets mortgaged to the banks but not convertible into cash and reimbursing the banks with some agreed value for such mortgages. This, in other words, is taking over of the bank’s sins by the Government. There was a protest to the use of tax- payers’ money to redeem the sins of others. These “others” were not holy men. At the inception of the party they paid their top managers unprecedented and exorbitantly high salaries and bonuses which were not reasonable by any standard. These high salaries and bonuses fuelled overconsumption and premature consumption. A similar situation has arisen in Sri Lanka. When the Pramukha Bank collapsed, the government had to intervene and take over the sins. When the persons who collected deposits promising high interests absconded, the depositors insisted the government to pay them. But the Government of Sri Lanka has not agreed in keeping with its policy or inability to pay. If someone is pointing his finger

at the Government when his estimation had gone wrong, the proposition as to why shouldn’t the government intervene at the very outset is reasonable. But the question arising here is whether even the government is capable of making correct estimations. The crucial point is what is correct? Is what is correct for the government, correct for the public as well? There’s no simple answer to the debate because underlined reasons were not simple. The argument from another direction is that the government should not intervene seriously simply because of misconduct by a few at the height of the economy.

State intervention in the market has taken place repeatedly in Sri Lanka. A recent example is the introduction of a very high fertilizer subsidy. The objective was to increase the income of the farmer with the end result of raising his purchasing power. Government intervention in this case is justifiable as it is aimed at supporting a section of the people to at least attain a general consumption level which they had failed to reach. It is paradoxically different from intervening to save those who had fallen from their heights of overconsumption. The World Bank and other agencies who have presented themselves to provide policy advice and grant aid to poor countries do not accept or are not willing to accept the fact that the majority are not in a position to reach a generally accepted level of consumption because of the overconsumption of a minority. Until and unless this basic factor is accepted and solutions drafted accordingly, it will not be possible to prevent the occurrence of serious economic crises in countries throughout the world. Consequently, no world peace from country to country could be attained.

It is no use preaching to a person with no food to eat, no house to live in and no immaculate clothes to wear, the glamour of complacency, or leading a simple life or an environment-friendly life or about the happiness derivable through the lessening of expectations and desires. No use telling fairy tales about future prosperity. No crises can be prevented or peace attained through such preaching.

It is said that the seriousness of the economic disaster could have been reduced if a considerable intervention of the Government had been there. The Head of an American company dealing with

forward-buying, giving evidence before a Committee of the United States Congress has said that if not for their activities, the enhanced oil prices could have been reduced. Because of the prices inflated by the activities of such companies the whole world faced a crisis. They inflated the prices in order to gain abnormal profits and exorbitant salaries and bonuses. Such unlimited income was utilized for overconsumption. As referred to in this document time and again the epicentre of the crisis is overconsumption and premature consumption.

The relative share of agriculture, industry and services in gross national product is a criterion for measuring the stage of development of an economy. It is assumed that an economy whose services hold a higher percentage in its relative share has attained a higher stage of development than an economy whose percentage is lower. This does not mean that total output in agriculture or industry has been reduced. It means that the services sector has expanded and grown at a higher speed than the other two sectors and the monetary value of its output has increased. Also, it could be a result of the reduction in the relative prices of agricultural products. Simultaneously, the share of expenditure for food in the consumers’ expenditure list also decreases in such situations. Food expenses of an American which was 30% of his income have been reduced to 10% during the last 30 years. This does not mean that the American meal has been reduced in its content. His income has increased and food prices have relatively been decreased. The list of other requirements has been lengthened. He has reached an income level to afford them.

Services economy has no base of its own. At the first or a subsequent step it will combine with agriculture or industry. In this sense, the foundation of an economy is agriculture and industry. For instance, transport falls within the service economy. There’s nothing to transport if there is no agriculture or industry. Insurance falls within the service sector of the economy. Vehicles are insured. Vehicles are linked with transportation and transportation is linked with agriculture or industry. This means in the final analysis insurance cannot exist without agriculture and industry.

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Beside transportation and insurance, finance, trade, tourism, health, education, entertainment, art, dancing and music fall within service economy. At a glance a higher level of living standard is a reflection of an increased and expanded service economy. “Higher Living standard” has a relative meaning. There may be different views as to whether the “higher living standard” chased after in an unprecedented speed in the recent past was bearable by the economic foundation and the pressure exerted by the financial economy, was beneficial or harmful. There may be various schools of thought. When debates become more and more critical and academic it becomes difficult to come to conclusions as to what is right and wrong, what is correct and incorrect? Final judgment will be based on empirical evidence. The judgment passed and the punishment has now been announced. What the judgment says? The over- consumerist upscaling of lifestyle norms irrespective of the ability to pay chased after and acquired by a minority, the first world, are too heavy and can no longer be borne by the economic foundation (agriculture and industry). That superluxury

living style is not realistic. What is the punishment levied? The overconsumption and superluxury lifestyle of the first world should be suspended and even the generally accepted level of consumption of the second world should also be cut considerably for ‘n’ number of years. The number ‘n’ is still unknown. In short, the economic recession was enforced. The punishment is for the entire world. But the weight of the punishment is different from person to person. Those who had risen to a very high level of overconsumption had a deeper downfall. Those who had climbed a minor height had a minor fall. Everyone fell one upon the other according to his merits and demerits.

During the recent past, prices of certain goods increased artificially. These price hikes cannot be explained by the principles of supply and demand of economics. As mentioned earlier, it was the purchasing power of the consumer raised high by financial instruments which has caused this. He who did not need a new house also bought a new one. A more luxurious motor car was bought in addition to the one already in possession. Excessive demand from a pair of shoes

to a diamond necklace, from a recreationery trip to an over the sky tour was experienced. Obviously, prices increased as it should have been. A series of cross-adjustments of prices also took place. When the prices of oil increased, efforts at producing biofuel from maize and sugar led to an increase in the prices of maize and sugar and related products. Because wheat fields were converted into maize cultivation, the price of wheat increased. Bread prices increased. When palm oil was used as fuel, its price increased. As a result of changes in consumer pattern because of increased income, the quantum of meat consumption increased (especially in China). Prices of meat products increased. Overconsumption and premature consumption created a situation of inflation. Two passengers in two parallel trains running in the same direction will not feel the real speed. Similarly, overconsumption and inflation, for a short period of time, ran parallel with accelerated economic activity catalyzed by such overconsumption and inflation. Nobody experienced the real speed until collision. Overconsumption at high prices created a massive consumer deficiency, a scarcity

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and a loss. Consumer deficiency is the complete opposite or reciprocal of the consumer surplus referred to in economics. Consumer surplus occurs when, depending on his satisfaction (utility), the value placed by a consumer to a certain article exceeds the market price of that article. For instance, a consumer in search of a beautiful dress decides to purchase the material of his choice at the first shop if the price is below rupees five hundred. That means his value for the dress is rupees five hundred. Thereafter he sees a dress similar to what he has in mind in another shop and this time he may place a value of rupees four hundred for it as he already has one. However, he pays both dresses the selling price displayed. If the selling price of the two dresses is only rupees three hundred and fifty each, it is said that there is a consumer surplus of rupees two hundred. (500+ 400 – 700). The third similar dress he comes across might worth him only rupees three hundred only since he is already in possession of two dresses. He will not buy a third dress as its selling price is rupees three hundred and fifty. During the pre and inter-recession period the consumer had to purchase at high prices contravening his utility and satisfaction. For example if he had to purchase a shirt worth rupees five hundred in utility value for rupees six hundred he will face a loss or a consumer deficiency of rupees one hundred.

One real-world illustration is how one had to pay above the real cost for travelling and transportation due to increased fuel prices in Sri Lanka. Similar consumer losses were distinctly witnessed in the cost of houses, medicine, milk powder, and electrical and electronical equipment. A consumer deficiency and loss for that matter certainly took place in relation to all products and services due to internal linkages and cross-connections in ways and means of production.

One clear-cut decisive situation of deficiency and loss due to high prices occurs when capital for businesses is acquired at very high interest rates. Massive deficiency and loss can occur to a business enterprise when it has to borrow funds at a rate higher than the rate that it places for capital acquisition based on its performance and profitability. Consequently, it has to decide either to increase the prices of goods and services it produces and pass on the loss to the consumer or face a close-down

where no more price increase is possible. A reduction or no increase situation of the salaries and bonuses of employees will take place. Some have passed on the loss to banks and financial institutions by defaulting payments or to governments by not paying taxes. It is only a transfer but the economy as a whole carries the loss somewhere within. Against this backdrop swaying swords against each other will not solve the problem. It will only be an internecine struggle. Government exercising its penal powers to collect taxes to the cent and banks chasing after defaulters and business entities offering all sorts of cut-throat discounts are examples. What will save the country will be an economic philosophy encompassing all parties including government, banks and financial institutions, business entities and consumers. Until the losses accrued to the consumers and businesses in all the countries right throughout the world are fully recovered the economic recession will haunt the world. In Sri Lanka the euphoria over war victories was used to wrap up this loss. Yet, if the multifarious costs of war are added to the ill effects of the economic recession, a deficiency will still remain. Not only that, time is required to turn the war achievements into objective economic benefits. Certain economists opine that the bottom of the precipice is not discernible as yet. That opinion suggests that the fall is much deeper. The inferred date of return of world economy to normalcy is pushed further. The finger of hope is stretched towards the year 2011.

The code of instructions supplied to poor countries by the developed and rich nations and the international monetary organizations does not signify ways of rectifying the economic anomaly of the distribution of income. Their recipes of instructions contain only advice on keeping destitute alive once they surface. An anomaly of wealth distribution in poor countries is an advantage for the rich and developed countries. Because a market for their luxurious goods and services will be created in poor countries as well. The economic burden of these luxurious goods and services on poor countries is much heavier than such burden on rich countries. Because we have to pay a large number of rupees calculated at the prevailing exchange rate for each dollar payable. Exchange rate for the dollar at present is one hundred and fifteen. At the same time, we have to compare such

luxurious style with the people of a nation who are not in a position to acquire even their basic needs.

Changes also occurred in the educational arena encouraging the super race which was run at a high speed ignoring the norms and boundaries of the economic and financial arenas. Citizens became consumers. States became consumer conglomerates. Paperless transactions occurred. Electronic mail and the internet made this process easier. State boundaries were faded away. Language of the electronic media belittled all living languages. The technical weightage in the school curricula increased. The objective of education of producing a reasonable man has slipped away.

Professional ethics and conduct were neglected. Making profit by cheating the public with misguiding and incorrect information was no longer considered a disgrace. The level of fraudulency of behaviour of the Enron of America and its auditors in 2001 was revealed to the whole world. Many similar incidents came into light from America and Europe. Misbehaviour similar to Enron was revealed from the gigantic Satyam Company of India (a company employing about 53,000 personnel) and its auditors, PriceWaterhouseCoopers.

Examining the world economic recession in its economic, social and cultural profile we find that we in Sri Lanka also have faced all those situations and circumstances. Time is ripe for us and the entire world to take stock intelligently of the way we have behaved in the economic sphere so far. The entirety of economics and macro-economics in particular has to be reinvented. In the efforts for the economic development and the upliftment of the lifestyle, we have to take not only the present but also the future into consideration. Economic and social peace has got to be targeted alongside economic development. Resources of the world, personal, national and international, should be utilized with due care. In Buddhist discipline it is stated that once a robe of a monk is discarded, it should be cut into pieces and used for various purposes until using as a doormat in the end. King Parakramabahu the Great’s announcement that not a single drop of rain should reach the ocean unused bears similar meaning. This is a lesson not for us only, but for the whole world.

e-mail : [email protected]

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An Interview with Dr Koshy Mathai, IMF Representative in Sri Lanka

Churchillian view of The Economy and the

IMF Program

making inroads into a deteriorating economy, and continued large fiscal deficits which were financed increasingly from external sources causing further issues when the global crisis brought despair. CBSL’s approach in defending the rupee by selling Dollars at the expense of Reserves was seen as “Triumph and Tragedy,” in that the rupee was kept from falling too far too quickly, but at a sacrifice of much-needed dollars that was not sustainable.

According to the IMF Representative the next phase could be seen as “Their Finest Hour,” narrowing the Trade Deficit (reasons being lower

demand for imports due to the Economic downturn), recovery of remittances, dramatic change in investor sentiment (CSE indices record heights) resulting in foreign investor enthusiasm leading to higher capital inflows and lower

The Sri Lankan Economy, its setbacks and IMF assistance has been a much talked topic in the country; impending gloom and hidden agenda of promises to the lender were direct accusation against the government in media and many forums. However it was not all gloom as the prophets advocated but a positive forecast for a nation poised for economic recovery and massive development programs taking place after nearly three decades.

Dr Mathai, borrowing from the titles of Churchill’s famous multivolume history of World War Two—started by describing “The Gathering

Storm,” that is, the build-up to the economic difficulties that peaked in early 2009. He highlighted the rising oil price widening the Trade deficit, Remittances a significant source of external financing declining, loss of global investor appetite

spreads, rebuilding CBSL reserves, stable Rupee, lower inflation and interest rates resulting in gradual growth accompanied by recoveries in imports and fiscal revenues. Though the outward appearance of the Presidential directive on state bank lending rates was initially not seen as positive the results have been rewarding with lower cost of funds to the industry. Global recovery still being weak with expected 3.1% growth. Dr Mathai then turned to a description of the IMF program, again borrowing lightheartedly from Churchill in terming it “The Grand Alliance.” Performance to date has been encouraging. Mathai in spelling out the IMF program of $ 2.6 billion loan in 8 tranches linked to quarterly reviews outlined the main targets.

• Reserve Accumulation (Borrowed vs Non-Borrowed)

Present reserves amount to more than USD 5b and though concern has been raised on risks of borrowed funds no short-term problem exists as much of these monies are invested in longer-term instruments for which the secondary market is not that liquid, and money cannot be withdrawn too quickly.

• Appropriate Monetary Policy

• Deficit Reduction with provision for Reconstruction

Contrary to widespread speculation, the IMF Representative firmly assured that secret conditions do not exist, adding further he confirmed that July and September targets achieved. Problems do not exist with reserve accumulation or monetary policy, but he cautioned that meeting fiscal targets ahead would be challenging...

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• Structural benchmarks (e.g., tax reform, State-owned enterprises with particular emphasis on Petroleum and Electricity Board, financial sector, etc.)

Contrary to widespread speculation the IMF Representative firmly assured that secret conditions do not exist, adding further he confirmed that July and September targets achieved. Problems do not exist with reserve accumulation or monetary policy, but he cautioned that meeting fiscal targets ahead would be challenging and would require a further recovery in revenues along with substantial policy changes to reduce the deficit as planned by the government to 6% of GDP in 2010 and 5% of GDP in 2011 (excluding some provision for spending on specific, monitorable reconstruction projects) Fiscal policy. He added that two tranches were already disbursed and the third could be considered in the first half of the

first quarter of 2010. Dr Mathai did caution that potential loss of the GSP concession could result in loss of employment and concluded with a possible turning-point for the economy with the cessation of the war.

While the Financiers could assist us through funding and close monitoring it’s not only the Economic factors that could take a country forward, Industrial Peace and discipline are essential ingredients. In the recent past country has witnessed a surge in strikes, work disruptions etc bleeding the economy. The plantation strike despite the existence of a Collective agreement caused immense losses to country’s vital Agricultural exports while the disruptions to the distribution of Petroleum virtually brought the wheels of Economy to a grinding halt. Both the Port and the Petroleum sector could not be crippled fully due to Private sector stakes in these crucial sectors.

The Government, Opposition and the Trade unions must act with responsibility in dealing with these nationally-sensitive sectors. Investors look for Industrial peace and the country needs scientists & Technical experts to maximize the benefits of a rare opportunity after thirty years of conflict.

(An Interview held with Sunil Karunanayake based on a Presentation held in Colombo in December 2009)

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By Rex Olegasegarem BA (Econ.), FCA, FCMA, CPA (Australia)

Reminiscence of an Articled Clerk in the Early

Days of the Institute

representatives of the Accountancy firms and the aspiring candidates were allowed to nominate their preferences and the selection of the successful candidates was determined by matching the preferences. I found the interview with the panel of partners from the respective accountancy firms rather interesting. Mr. Turner Greene of Turquand Young’s (now Ernst & Young) & Mr. B.R. de Silva of B.R. De Silva & Co., were more interested in my sporting achievements in the University, from captaincy of teams, colours awarded to the details of the timings recorded in the athletic events won by me. Mr. Turner Greene was a sports fanatic and Mr. B.R. de Silva was the founder and first president of the Ceylon Track and Field Club (CT & FC).This showed that the top people in the accountancy fraternity at that time were not stereotyped mundane accountants, on the contrary they had diverse interests.

In 1959 and for some years thereafter, the normal articled clerks had to pay a premium (ranging from Rs. 2000 to Rs. 5000, a large amount at that time) to the accountancy firms concerned and did not receive any form of compensation for their services, except a return of the premium in monthly instalments of Rs. 40 per month or a refund

The year was 1959 A.D. when the newly formed Institute of Chartered Accountants of Ceylon, established by an Act of Parliament (No. 23 of 1959) succeeded the existing Registered Accountancy Board. The qualified Registered Accountants (R.A.) of the Registered Accountancy Board and the members of the Chartered Institutes of England & Wales and of Scotland resident in Ceylon were invited to become members of the new ICAC. The first President was the then Auditor General, Mr. L.A. Weerasinghe (member of the Chartered Institute of England & Wales) and the first secretary was Mr. Nesaratnam, a public servant. The office of the institute located in a couple of rooms in a Government building

was manned by an ebullient, energetic, and efficient middle-aged gentleman, Mr Fernando. He was the Administration Officer, clerk and messenger all rolled into

one. He was really the “face” of the institute to the few articled clerks in the early days.

My foray into the Institute was also in 1959 (November), perhaps one from the first batch of the newly recruited graduate articled clerks under the banner of the Institute. There were non-graduate articled clerks as well. I was selected through the Ceylon Government Scholarship scheme for Graduates to sign Articles with a leading firm of Chartered Accountants, Ford, Rhodes. Thornton & Co. (now KPMG). The selection process for the scholarship at that time was in two stages - a panel of University of Ceylon dons interviewed the candidates and submitted a shortlist and this was followed by a

panel of representatives (either the chief partner or the staff partner) from the Chartered Accountancy firms interviewing the candidates from the shortlist. Both the

In 1959 and for some years thereafter, the normal articled clerks had to pay a premium (ranging from Rs. 2000 to Rs. 5000, a large amount at that time) to the accountancy firms concerned and did not receive any form of compensation for their services, except a return of the premium in monthly instalments of Rs. 40 per month or a refund of the total premium at the end of articleship.

20

of the total premium at the end of articleship. As an articled clerk on scholarship, Ford, Rhodes,Thornton & Co ( FRT&CO) waived the premium requirement and paid all my study expenses including the correspondence course from Foulks, Lynch & Co. (a popular course from England followed by nearly all articled clerks at that time). The firm also paid me a salary - a “princely” sum of Rs.40 per month and increased it to Rs.75 on completion of the Intermediate examination. I believe all scholar-ship candidates from other firms enjoyed the same benefits in terms of the scholarship.

The period of mandatory apprenticeship with an accredited firm of Chartered Accountants for articled clerks was three years in respect of graduates and five years for non-graduates at that time. This period was certainly a very busy one, having to work very hard maintaining strict time schedules on all the accountancy/audit/tax assignments and also lead the audit teams to the clients’ offices in the latter part of the articled period, interspersed with very demanding examinations. The two examinations – Intermediate and Finals – had two parts each, with a choice to sit for either one or both parts of the same examination at the one sitting. The examinations were difficult and to some extent competitive as the pass or success rates at that time was very low .This low pass rate had more to do with the Accountancy Board and the Institute setting high hurdle rates rather than the performance of the candidates. In the context of only a few venturing into this field at that time, the number of successful candidates passing both the intermediate and final examinations could be counted on your finger- tips. Although providing very little comfort to the examinees at the time of confronting the examinations, this approach benefited the few successful candidates in their ability to command a significantly higher remuneration compared with their compatriots in other professions due to the supply-demand situation.

The incidence of candidates passing both parts of the Final Examination at the one sitting was so very rare that in December,1961 when Norshi Lakdawalla of Ford, Rhodes, Thornton & Co accomplished this feat at his first attempt, Mr. Fernando of the Institute came to the Company premises to deliver the good news to Norshi personally. Since

I happened to be at the office, Mr. Fernando informed me (to my great delight) that I had passed both parts of the Intermediate Examination, which I sat at the same time. Norshi Lakdawalla was a model articled clerk, achieving the same result earlier at the intermediate examination and leading the audit teams to some of the bigger clients at that time (Walker Sons, Brown & Co etc.). In earlier years. Norshi was also the All-Ceylon Table Tennis Champion at the tender age of fourteen years while a student at St. Thomas’ College, Mount Lavinia. This was another example of the extracurricular achievements of the Chartered Accountants at that time.

In relation to the enormous difficulty in passing the institute examinations at that time, the story gets even more interesting. When I fronted up for Part 1 of the Final Examination in December, 1962, the Financial Accounting question paper unleashed on us was more of a difficult puzzle and completely different to any of the past examination papers. It was also totally different to the examination papers of the ICA (England & Wales) embodied in the “Chartered Telephone” publications. We worked on these publications assiduously in our preparation as our institute was modelled on the ICA of England & Wales and our answers were “moderated” by their examiners at that time. On a quick glance of the questions I realized the first (carrying 40 marks) was very long, intricate and some sections unfathomable that it might take me the entire three hours allocated for the whole paper to unravel this one question and yet not be assured of getting the full marks for it. Although shorter, the second question was completely mind-boggling. The third appeared to be workable up to a point and then became equally a maze similar to the second. By this time I had started sweating and a certain failure was staring at me with only the last question left – the shortest and worth only 15 marks (out of a total of 100). The last question on “containers” appeared to be workable, hence I launched into it hoping to collect 15 marks in even time. However, it absorbed nearly one hour (33% of total time) since it had its own”twist and turns” as I worked through. I realized that I had absolutely no chance of working out the more difficult problems in the other questions within the balance two hours. It was now a question of collecting as many marks as possible within the available two hours. Alas, this task proved to be

extremely difficult as I found to my horror that the other problems were more difficult than anticipated at the first glance. By this time I was in a bath of sweat. With tension rising to an unprecedented level, I lost at least ten more valuable minutes having to head for the toilet, followed by an invigilator although there was no possibility whatsoever of my gaining any unscrupulous advantage except to recover some sanity. At this stage, I was very tempted to give up as I felt my working through the other problems did not appear to be heading in the correct direction. In sheer frustration I crushed some of my worksheets and put them down on the floor. In the meantime, the closing bell was fast approaching and my tension was increasing further. Then, the dreaded announcement of “five minutes more, please tie up your answer sheets” came on. Fortunately, despite the horrible situation, I had the presence of mind to pick up the crumpled worksheets, straighten them out and add them on to the answer package in the correct sequence hoping that some marks could be picked up in those workings, However, I was certain that my performance will not secure a pass grade in that subject and this meant that I would have to repeat the whole of the Part 1 examination as there was no referral in one subject. As I walked out of the examination hall with the horrible prospect of certain failure before me, I noticed the look of bewilderment on the faces of my colleagues. Spotting Vijayasekeran (later, a partner of Turquand, Young & Co, and now residing in Perth, Australia), who was one of the brighter students in our batch, I asked what he thought of the paper and his immediate response was “ I have no chance at all of passing this paper. It dawned on all that no one will pass Part 1 of the Final examination on this occasion.”

The untenable situation at this examination produced a swell of agitation among the examinees. We had a protest meeting at the Institute and a small committee was appointed headed by that “maestro” John Diandas of Macan Markar. The committee was empowered to dissect the questions for any anomalies, evaluate them in relation to the purpose and fairness of the examination and also liaise with the local examiners, external moderators from U.K. and the Institute. The external moderators had commented that the questions were more of a difficult quiz or puzzle rather than an assessment

21

of the candidates’ knowledge in financial accounting. There were a number of anomalies as well in the questions which made it difficult for the candidates to work through. The examination committee of the Institute considered the representations carefully and lowered the hurdle rate or the total marks required to pass the paper in Financial Accounting. Consequently six candidates (including Vijayasekeran and myself) passed Part 1 of the Final examination. Perhaps, attaching my crumpled worksheets helped me to get over the line.

In view of the number of articled clerks being limited, we had the benefit of knowing well each member of the fraternity in our batch from all accountancy firms. I recall there were only twenty five signatories to the attendance sheet for the intermediate lectures from all firms in 1960/61. We had five articled clerks in my batch at Ford, Rhodes, Thornton & Co. (FRT), with one ending up as my “best-man” later on. However, there were few more senior articled clerks either preparing for the final examinations or repeating the intermediate examinations. This

Firm had very strict codes regarding dress and general presentation. We had to be clean-shaven at all times and wear well-laundered white shirt, white trouser and tie. The tie can be somewhat irksome walking or travelling by bus to the client office in the sweltering humid heat of Colombo and it was difficult for the young articled clerks to be spotlessly clean-shaven at all times. Consequently, some of us got pulled up for letting down the tie knot or not using the best blades for the shave – “ We don’t like uncouth Frenchmen“ thundered the Anglo Saxon senior partner. Despite our very busy working schedule and demanding examinations, the articled clerks at FRT had an enjoyable social life. Every Friday morning, when we all came into the office (then located on the fifth floor of the Times building in the Fort) for our weekly reporting session, we would adjourn to the Colombo YMCA cafeteria for a quick cup of tea before dispersing to the client offices. Our group also met for drinks and dinner almost monthly, and these events sometimes ended up with singing popular songs and bailas rather raucously, fuelled by “high spirits”. We also ventured out on a very enjoyable trip to Kandy

Okande and Yala in a minibus. Apart from the thrill of watching the bird life in Okande and the animal life in Yala, we also enjoyed rather excessively the fresh curd and treacle, with some having to pay for this excessive indulgence by way of frequent bowel evacuations in the most natural of environments. It was not always easy to make it to the next town in time.

A very memorable experience as an articled clerk came to an end in June, 1963 when I completed the final examination – six months after the minimum period as I spread out Parts 1 and 2 of the final examination over two separate sittings. Two remarkable gentlemen during this period had a significant impact on my career. Mr. N.G.P. Panditharatne, then a senior partner of FRT & Co. was my Principal and mentor, He was well respected in the professional/business and political circles, yet down-to-earth, capable and very helpful at all times ensuring that his articled clerks wishing to move into the commercial arena after completion were set up in good positions. The other gentleman was Mr. Thillairajah, then Chief Accountant of Whittal Boustead

22

“The Chartered Accountant” Third Quarter Issue Dear Member

Given the positive developments in the country and the emerging global recovery we intend covering the following theme for the next issue

Economic Resurgence in Sri Lanka - Miracle of Asia Members are encouraged to provide articles to suit this theme. Completed articles in MS word format, not exceeding 1000 words together with the writers’ credentials and a passport size photograph should be forwarded to reach Ms Khema Senanayake ([email protected]) not later than 15th August 2010. Given the space limitations responsive articles in order of receipt will be given priority.

Thank YouSunil KarunanayakeEditor “The Chartered Accountant”

31st National Conference of ICASL 28th – 30th October, 2010 at Water’s Edge Annual national conference of the institute will be held during 28th-30th October, 2010 at the Water’s Edge. The conference this year will be positioned as a business summit, and is expected to be attended by key business leaders and policymakers. The key speakers and the resource panel will comprise of international speakers of repute, renowned industry leaders, and key policymakers in the government.

Please Include the conference dates in your diary and attend the inauguration session of the conference on October 28th, 2010 and the technical sessions on October 29th and 30th. You will receive an invitation for the inauguration and a brochure to register for the technical sessions in due course of time.

& Co. and our lecturer/tutor in Financial Accounting. When I commenced my course I was not very sure whether accounting should be my career although I graduated in economics with accountancy as my special subject. While at the University, accountancy did not really grab me. However, Mr. Thillairaja, brilliant in his field brought home the basics of accounting including “Debits and Credits” so much alive and meaningful that I began to enjoy my course. When the exams were around the corner, Mr. Thillairajah would give us very useful hints on how to approach them, including saving time on long problems and earning as many marks as possible from difficult questions although unable to arrive at the ultimate correct solutions. All these helped me in the dreaded exam of December, 1962.

The other huge factor helping me to enjoy the course was the breadth and intensity of practical experience gained at FRT & CO. The large clientele of this Firm was spread out into all the sectors of the economy. The popular “Lander” system of management information reporting for the Plantation sector was developed by Mr. Lander, a former chief partner of FRT & Co. This was an excellent management reporting package which could hold its own to this day and helped to underpin the efficient tea industry in Sri Lanka at that time. The Lander prize for Accounting in the Intermediate examination for an outstanding performance was named after this gentleman.

Subsequently, I did have the pleasure of serving on a few committees of the institute in the seventies, including the one responsible for the award

for the best Annual Corporate Report. Hayleys Ltd was the winner then and I note that it had continued to win this award on many occasions thereafter – a remarkable performance. I had also the pleasure of conducting a few lectures and tutorials in Management Accounting for the students in the early seventies at the request of the very respected and capable Director of Studies, Mr. A.T. Benedict.

The Institute has come a long way from that time. To this day, I enjoy reading the journals of the Institute and it is heartening to note that the institution has grown in size and diversity.

I wish the Institute all the very best for the future and am confident it will continue to play a significant role in the business and commercial life of Sri Lanka.

23

20th President’s Induction

Pre-Election Budgetary Position Report

ICASL Events

From left to right : Mr. Sujeewa Rajapakse, Mr. Sujeewa Mudalige, Chief Guest Dr. P B Jayasundera, Secretary to the Treasury, Mr. Nishan Fernando and Mr. Aruna Alwis

President Mr. Sujeewa Mudalige handing over a memento to Mr. Ranjith Fernando who moderated the discussion at the “Pre-Election Budgetary Position Report” Seminar held on 30th March 2010

Mr. R Senathi Rajah Senior Partner Julius & Creasy, Mr. J M Swaminathan, Partner Julius & Creasy, Mr. Ken Balendra, Former Chairman & CEO John Keells Holdings, congratulating Mr. Sujeewa Mudalige, the New ICASL President

Outgoing President Mr. Nishan Fernando,officially inducting the New President of ICASLMr. Sujeewa Mudalige; Vice President Mr. Sujeewa Rajapakse in the background

Interactive discussion on “Pre-Election Budgetary Position Report” Seminar held on 30th March 2010 - L to R: Mr. Ranjith Fernando, Mr. Rienzie Wijayathileke, Mr. Chandra Jayaratne, Mr. Kulatunge Rajapakse and Mr. Mahinda Siriwardena

24

Published by the Technical Directorate of the Institute of Chartered Accountants of Sri Lanka

Issue 1 & 2 of Volume 6

At the recently concluded SAFA Regional Standard-Setters Conference held at the Cinnamon Grand Colombo, Mr. Reyaz Mihular, Chairman of the SAFA Committee on Accounting and Auditing Standards hands over the booklet published by the Technical Directorate of the ICASL on SAFA Countries vis-à-vis International Accounting and Auditing Standards to Sir David Tweedie, Chairman of the International Accounting Standards Board (see inside for more photographs).

Editorial Board

Chamila Cooray - Head of Technical

Subhashini Vithanachchi - Technical Manager

Kamal Saseedaran - Quality Assurance Manager

Upendra Wijesinha - Technical Manager

Technical Editorial Advisor

Richard Ebell FCA, FCMA, Dip.M, MCIM

Chairman, ICASL Financial Reporting Faculty

Typesetting & Graphics

Reza Mannan - Executive

INSIDE THIS ISSUE:

1) Readers’ Forum

2) Code of Ethics

3) Financial Reporting Faculty/Urgent Issues Task Force

3.1) Sri Lanka Accounting Standards Application Guidance No. 7

3.2) Sri Lanka Accounting Standards Application Guidance No. 8

4) Audit Faculty/Auditing Standards Committee

4.1) Sri Lanka Audit Practice Statements (SLAPS), Sri Lanka Standards on Assurance Engagements (SLSAE) and Sri Lanka Standards on Related Services (SLSRS) to be reviewed

4.2) Sri Lanka Standards on Review Engagements to be adopted by the Council

4.3) Sri Lanka Standards on Assurance Engagements to be adopted by the Council

4.4) International Standards on Auditing (ISA) Clarity Project

5) Accounting Standards

5.1) Standards to be adopted by the Council

5.2) Standards to be reviewed

5.3) Standards under Improvement Project II adopted by the Council

6) Global Scene • Hedging is a good idea

June 2010

Technical DirectorateThe Institute of Chartered Accountants of Sri LankaTel / Fax : 2594118 (Direct); 2352000 (Gen.); Email : [email protected]

QuarterlyTechnical Update

25

Readers’ Forum

Quotes

Economic depression cannot

be cured by legislative action

or executive pronouncement.

Economic wounds must be

healed by the action of the

cells of the economic body -

the producers and consumers

themselves.

Herbert Hoover

Better to remain silent and be

thought a fool than to speak

out and remove all doubt.

Abraham Lincoln

An onion can make people

cry, but there has never been

a vegetable invented to make

them laugh.

Will Rogers

It is necessary to help others,

not only in our prayers, but in

our daily lives. If we find we

cannot help others, the least

we can do is to desist from

harming them.

Dalai Lama

I’ve learned that people will

forget what you said, people

will forget what you did, but

people will never forget how

you made them feel.

Maya Angelou

NEW CODE OF ETHICS FOR PROFESSIONAL ACCOUNTANTSThe Institute of Chartered Accountants of Sri Lanka (ICASL) takes pride in leading

the profession towards reshaping and rebuilding the business world following

a period of economic bleakness. The ICASL understood the importance of

introducing a new Code of Ethics to govern and guide the profession. In driving

the business world towards truly sustainable development, the ethical conduct of

professionals is very important. Ethically-minded professionals are of great value

in safeguarding the interests of stakeholders. These considerations led the ICASL

to adopt the latest International Federation of Accountants (IFAC) Code of Ethics

for Professional Accountants.

The new Code of Ethics is in 3 parts.

Part A: General Application of the Code

Sets out the fundamental ethical principles that all professional accountants are

required to observe including integrity, objectivity, professional competence and

due care, confidentiality and professional behaviour. These fundamental principles

serve as a conceptual framework for the Code as it is not possible to define every

situation that can be encountered.

Part B: Professional Accountants in Public Practice

This part of the Code, which applies only to Professional Accountants in Public

Practice, covers in detail areas such as professional appointments, conflicts of

interest, second opinions, fees and other types of remuneration, marketing

professional services, gifts and hospitality, custody of clients’ assets. It also

includes a conceptual approach to independence that takes into account for each

assurance engagement, threats to independence, accepted safeguards and the

public interest. It requires firms and members of assurance teams to identify and

evaluate circumstances and relationships that create threats to independence

and to take appropriate action to eliminate these threats or reduce them to an

acceptable level by the application of safeguards.

Part C: Professional Accountants in Business

This part of the Code covers areas such as potential conflicts, preparation and

reporting of information, acting with sufficient expertise, financial interest and

inducements, which are relevant to Professional Accountants in Business.

The Governing Body of the ICASL believes the New Code of Ethics will strengthen

the profession and encourage trust in it.

The New Code of Ethics for Professional Accountants is available on the ICASL

website and became effective on 1 January 2010.

Code of Ethics

26

SRI LANKA ACCOUNTING STANDARDS APPLICATION GUIDANCE NO. 7Issued & published by the UITF

RECOGNITION OF RETIREMENT BENEFITS

ISSUE

Many corporates establish an independent Trust Fund, to which annual gratuity provisions are transferred. These Trust Funds are generally considered as separate legal entities. Gratuity obligations, at retirement are usually paid by the Fund.

Clarification is provided on whether the Company, in the above circumstance, can recognise interest income earned by the fund during the period, in arriving at the retirement benefit charge for the year.

STANDARDS

SLAS 16 Retirement Benefit CostsSLAS 16 Employee Benefits (Revised 2006) – applicable forfinancial statements beginning on or after 1st July 2007

DISCUSSION/ANALYSIS

SLAS 16 – Employee Benefits (Revised 2006) defines Post-employment benefits as “employee benefits (other than termination benefits) which are payable after the completion of employment”.

These include, for example, retirement benefits such as pensions, gratuity and other post-employment benefits, such as post-employment life insurance and post-employment medical care.

SLAS 16 (Revised 2006) paragraph 24 further states:

“Arrangements whereby an entity provides post-employment benefits are post-employment benefit plans. An entity applies this Standard to all such arrangements whether or not they involve the establishment of a separate entity to receive contributions and to pay benefits”.

Post-employment benefit plans are classified as either defined contribution plans or defined benefit plans, depending on the economic substance of the plan.

“Defined contribution plans are post-employment benefit plans under which an entity pays fixed contributions into a separate entity (a fund) and will have no legal or constructive obligation to pay further contributions if the fund does not hold sufficient assets to pay all employee benefits relating to employee service in the current and prior periods”. (SLAS 16 [Revised 2006] paragraph 7).

Thus, the employer only has the obligation for agreed contributions into such plans. This is charged as an expense for the year.

On the other hand,

“Defined benefit plans are post-employment benefit plans other than defined contribution plans”. (SLAS 16 [Revised 2006] paragraph 7).

In this situation the entity has an obligation to make good any shortfall in the payment of retirement benefits as stipulated by the entity. Therefore, the entity is, in substance, underwriting the actuarial and investment risks associated with the plan. Therefore it is apparent that the expense recognised for a defined benefit plan is not necessarily the amount of the contribution due for the period. (SLAS 16 paragraph 13 and SLAS 16 (Revised 2006) paragraph 49).

SLAS 16 Retirement Benefit Costs, which is applicable for financial statements beginning up to 1st July 2007, also defines Retirement Benefit Plans, Defined Contribution Plans and Defined Benefit Plans in a similar manner.

The Standards also proceed to state that defined benefit plans may be unfunded, or they may be wholly or partly funded by contributions by an entity, and sometimes its employees, into an entity, or fund, that is legally separate from the reporting entity and from which the employee benefits are paid. Such funds may even be administered by third parties. The payment of funded benefits when they fall due may be the obligation of the reporting entity or the fund itself, and payment may depend not only on the financial position and the investment performance of the fund

Financial Reporting Faculty/Urgent Issues Task Force

but also on a reporting entity’s ability and willingness to make good any shortfall in the fund’s assets. This is a critical criterion to be assessed in accounting for retirement benefit obligations.

For Retirement Benefit Plans, where the employer retains the obligation to pay the agreed level of benefits if there are insufficient funds in the plan, the employer should recognise the outstanding pension/retirement benefit obligation as a liability or asset at each balance sheet date. In determining the amount an entity is encouraged to use actuarial valuation techniques (valued by a professionally-qualified valuer or as described in the Standard). This is also enhanced in paragraph 46 of SLAS 16 Retirement Benefit Costs, which states that “the uncertainty inherent in projecting future trends in rates of inflation, salary levels and earnings on investments is taken into consideration in the actuarial valuations by using a set of compatible assumptions. ….” The revised standard also endorses this principle.

A number of steps are identified in determining the pension/retirement benefit surplus (asset) or deficit (liability).

1. Use actuarial techniques to make a reliable estimate of the amount of benefits employees have earned in return for their services in the current and prior period.

In doing so the company should use unbiased reliable demographic and financial assumptions, such as expected employee turnover, life expectancy, and discount rates and salary increments etc.

2. Determine the present value of the defined benefit obligation and the current service cost by discounting the estimated benefits using the projected unit credit method.

3. Determine the fair value of the plan assets. The expected return on plan assets is a component of amounts recognised in the profit or loss, each year, in relation to a defined benefit plan. The expected return ideally equates actual return, in the long term. Further, reporting the actual return in a single period would introduce significant volatility into the employer’s profit or

27

loss. Thus, the difference between the expected return and actual return is considered under actuarial gains or losses for the period.

4. Determine total actuarial gains and losses and those which should be recognised.

Actuarial gains and losses comprise the differences between actuarial assumptions previously made and what has actually occurred, experience adjustments, and the effects of changes in assumptions for the future.

5. Determine the level of any past service cost where a plan has been changed or introduced in the period.

6. Determine the gain or loss resulting from a curtailment or settlement of a plan, if appropriate.

Thereafter the results may be recognised on a net basis, in determining the retirement benefit obligation as at the balance sheet date as shown below:

The present value of the defined benefit obligation at the balance sheet date xxx

Plus : any deferred actuarial gains or xxx

Minus : any deferred actuarial losses (xxx) any past service costs not yet recognised (xxx)

the fair value of the plan assets at the balance sheet date (xxx)

Amount recognised as the defined benefit liability at the balance sheet date xxx

These steps are automatically carried out in performing an actuarial based valuation, whether carried out by a qualified actuary or otherwise. In doing so, the calculation of the present value of defined benefit obligations and assessment of fair value of the pension assets should be carried out with sufficient regularity, to ensure that the amounts recognised are not materially different to those that would be determined as at a balance sheet date.

Opinion

The Company shall use the steps given under the Discussion/Analysis above, in determining the charge for the year, and the defined benefit obligation as at a date, that takes into account the income earned by the fund during the said period.

31st December 2007

SRI LANKA ACCOUNTING STANDARDS APPLICATION GUIDANCE NO. 8Issued & published by the UITF

APPLICATION OF SLAS 30 (REVISED 2005) RELATED PARTY DISCLOSURES, FOR FINANCIAL INSTITUTIONS

ISSUE

SLAS 30 – Related Party Disclosures (Revised 2005) requires a considerable amount of disclosures to be made in financial statements of companies. Disclosures are more complex due to the nature of the business of financial institutions. Financial institutions would generally include banks, finance companies, and other entities which provide financial services.

Clarification is sought on the following:

1. Whether the Corporate Management of a financial institution shall be included under the definition of Key Management Personnel (KMP), in addition to the Board of Directors.

2. If Corporate Management of a financial institution can be defined as Key Management Personnel, is such financial institution required to disclose loans and advances including credit card balances, deposit account balances etc. of Corporate Management, even if loans and advances, deposits have been granted/accepted at the rates that are applicable to the general public or have been granted under schemes which are uniformly applicable to all staff of such financial institution?

3. In the event the Corporate Management is not included under the definition of Key Management Personnel, whet-her the financial institution is required to disclose the

transactions and balances pertaining to any member of the Corporate Management Team in the financial statements, if such person is appointed as a Nominee Director of a subsidiary.

4. Should the financial institution disclose the number of Key Management Personnel?

5. Is it adequate to disclose balances pertaining to transactions with Related Parties and Key Management Personnel, which are outstanding at the year-end only?

STANDARDS

SLAS 30 Related Party Disclosures (Revised (2005))

SLAS 23 Revenue Recognition and Disclosures in the Financial Statements of Banks

SLAS 33 Revenue Recognition and Disclosures in the Financial Statements of Finance Companies

DISCUSSION/ANALYSIS

Sri Lanka Accounting Standard 30 Related Party Disclosures (Revised 2005) specifies the following definitions,

“Related party A party is related to an entity if:

(a) directly, or indirectly through one or more intermediaries, the party:

(i) controls, is controlled by, or is under common control with, the entity (this includes parents, subsidiaries and fellow subsidiaries);

(ii) has an interest in the entity that gives it significant influence over the entity; or

(iii) has joint control over the entity;

(b) the party is an associate (as defined in SLAS 27 Investments in Associates (Revised 2005)) of the entity;

(c) the party is a joint venture in which the entity is a venturer (see SLAS 31 Interests in Joint Ventures (Revised 2005));

(d) the party is a member of the key management personnel of the entity or its parent;

28

(e) the party is a close member of the family of any individual referred to in (a) or (d);

(f) the party is an entity that is controlled, jointly controlled or significantly influenced by, or

for which significant voting power in such entity resides with, directly or indirectly, any individual referred to in (d) or (e); or

(g) the party is a post-employment benefit plan for the benefit of employees of the entity, or of any entity that is a related party of the entity”.

“A related party transaction is a transfer of resources, services or obligations between related parties, regardless of whether a price is charged”.

“Key management personnel are those persons having authority and responsibility for planning, directing and controlling the activities of the entity, directly or indirectly, including any director (whether executive or otherwise) of that entity”

Further FAS 57 Related Party Disclosures, (Statement of Financial Accounting Standard) adopted by the Financial Accounting Standards Board of U.S, defines Management as:

“persons who are responsible for achieving the objectives of the enterprise and who have authority to establish policies and make decisions by which those objectives are to be pursued. Management normally includes members of the board of directors, the chief executive office, chief operating officer, vice presidents in charge of principal business functions (such as sales, administration, or finance), and other persons who perform similar policy making functions. Persons without formal titles also may be members of management.”

As per the above definition, a Key Management Personnel (KMP) are persons who have authority and who are responsible for the policy making function of an entity. Therefore if there is a very high degree of delegation of authority & responsibility to Corporate Management in planning, directing & controlling activities (policy making) directly or indirectly, they may be considered as KMPs of the financial institution. The financial institution may evaluate this

position on a case-by-case basis, prior to identify its employees as Key Management Personnel.

SLAS 23 Revenue Recognition and Disclosures in the Financial Statements of Banks explains the disclosure of related party transactions in the following manner.

Paragraph 68

“Certain transactions between related parties may be effected on different terms from those with unrelated parties. For example, a bank may advance a larger sum or charge lower interest rates to a related party than it would in otherwise identical circumstances to an unrelated party; advances or deposits may be moved between related parties more quickly and with less formality than is possible when unrelated parties are involved. Even when related party transactions arise in the ordinary course of a bank’s business, information about such transactions is relevant to the needs of users and its disclosure is required by Sri Lanka Accounting Standard SLAS 30, Related Party Disclosures (Revised 2005)”.

Paragraph 69

“When a bank has entered into transactions with related parties, it is appropriate to disclose the nature of the related party relationship, the types of transactions, and the elements of transactions necessary for an understanding of the financial statements of the bank. The elements that would normally be disclosed to conform to Sri Lanka Accounting Standard SLAS 30, Related Party Disclosures (Revised 2005), include a bank’s lending policy to related parties and, in respect of related party transactions, the amount included in or the proportion of:

(a) each of loans and advances, deposits and acceptances and promissory notes; disclosures may include the aggregate amounts outstanding at the beginning and end of the period, as well as advances, deposits, repayments and other changes during the period;

(b) each of the principal types of income, interest expense and commission paid;

(c) the amount of the expense recognised in the period

for losses on loans and advances and the amount of the provision at the balance sheet date; and

(d) irrevocable commitments and contingencies and commitments arising from off balance sheet items”.

SLAS 30 (Revised 2005) requires the disclosures pertaining to related party transactions in the financial statements and states:

Paragraph 13

“To enable users of financial statements to form a view about the effects of related party relationships on an entity, it is appropriate to disclose the related party relationship when control exists, irrespective of whether there have been transactions between the related parties”.

Thus, related party identification and disclosures are required irrespective of the existence of transactions between them. These disclosures are believed to be essential because the external users need to be aware of the interrelationships between related parties, including the level of support provided by related parties. This will enable external users in their economic decisions.

Thereafter the Standard deals with the disclosure requirements in relation to KMPs.

Paragraph 16

“An entity shall disclose key management personnel comp-ensation in total and for each of the following categories:

(a) short-term employee benefits;

(b) post-employment benefits;

(c) other long-term benefits;

(d) termination benefits; and

(e) share-based payments”.

Therefore, it is evident that related party transactions may be disclosed in total, under the various or relevant sub-categories, rather than including details on an employee basis.

This is further enhanced by paragraph 22 which states the following:

29

“Items of a similar nature may be disclosed in aggregate except when separate disclosure is necessary for an understanding of the effects of related party transactions on the financial statements of the entity”.

Thus credit card details, loans and advances etc., may be disclosed in aggregate as discussed above.

Further disclosures that explain the transactions are required under paragraph 17 of the Standard.

Paragraph 17

“If there have been transactions between related parties, an entity shall disclose the nature of the related party relationship as well as information about the transactions and outstanding balances necessary for an understanding of the potential effect of the relationship on the financial statements. These disclosure requirements are in addition to the requirements in paragraph 16 to disclose key management personnel compensation. At a minimum, disclosures shall include:

(a) the amount of the transactions;

(b) the amount of outstanding balances and:

(i) their terms and conditions, including whether they are secured, and the nature of the consideration to be provided in settlement; and

(ii) details of any guarantees given or received;

(c) provisions for doubtful debts related to the amount of outstanding balances; and

(d) the expense recognised during the period in respect of bad or doubtful debts due from related parties”.

Therefore, it is evident that all transactions made with related parties shall be disclosed in the financial statements. This shall include all transactions during the year as well as the year end balances.

Further paragraph 21 of SLAS 30 (Revised 2005) states the following:

“Disclosures that related party transactions were made on terms equivalent to those that prevail

in arm’s length transactions are made only if such terms can be substantiated”.

Similar principles are discussed in SLAS 33 Revenue Recognition and Disclosures in the Financial Statements of Finance Companies, in relation to related party transactions and disclosures.

Opinion

1. For the Corporate Manage-ment of a financial institution to be included under the definition of Key Management Personnel, they should be responsible, directly or indirectly, in carrying out planning, directing and controlling activities (policy making activities). Nevertheless such financial institutions will have to decide on a case-bycase basis.

2. Corporate Management of a financial institution who are defined as Key Management Personnel, are required to disclose loans and advances including credit card balances, deposit account balances etc. even if loans and advances, or deposits have been granted/

accepted at the rates that are applicable to general public or have been granted under schemes which are uniformly applicable to all staff of the financial institution. However, they may be disclosed in aggregate.

3. This issue will not be applicable, for Corporate Management included un-der the definition of Key Management Personnel. On evaluation of the position on a case-by-case basis if Corporate Management does not come under the definition of a Key Management Person-nel, there are no disclosures required.

4. SLAS 30 (Revised 2005) does not require the disclosure of the number of KMPs.

5. The nature of the related party relationship, information abo-ut the transaction and the balances outstanding as at the end of the financial year/period should be disclosed.

31st March 2008

30

Audit Faculty/Auditing Standards Committee

The following Sri Lanka Audit Practice Statements (SLAPS), Sri Lanka Standards on Assurance Engagements (SLSAE) and Sri Lanka Standards on Related Services (SLSRS) are to be reviewed

The following Sri Lanka Standard on Review Engagements is awaiting Council adoption

1 SLAPS 1000 Inter-Bank Confirmation Procedures

2 SLAPS 1004 The Relationship Between Banking Supervisors and Banks’ External Auditors

3 SLAPS 1005 The Special Considerations in the Audit of Small Entities

4 SLAPS 1006 Audits of the Financial Statements of Banks

5 SLAPS 1010 The Consideration of Environmental Matters in the Audit of Financial Statements

6 SLAPS 1012 Auditing Derivative Financial Instruments

7 SLAPS 1013 Electronic Commerce—Effect on the Audit of Financial Statements

8 SLAPS 1014 Reporting by Auditors on Compliance with International Financial Reporting Standards

9 SLSAE 3000 Assurance Engagements Other than Audits or Reviews of Historical Financial Information

10 SLSRS 4400 Engagements to Perform Agree-upon Procedures Regarding Financial Information

11 SLSRS 4410 Engagements to Compile Financial Information

1 SLSRE 2400 Engagements to Review Financial Statements

The following Sri Lanka Standard on Assurance Engagements has been adopted by the Council

1 SLSAE 3400 The Examination of Prospective Financial Information

International Standards on Auditing (ISA) Clarity Project

The International Auditing and Assurance Standards Board (IAASB) commenced a project to clarify the International Standards on Auditing (ISAs), the so-called Clarity project, in 2004. The Clarity project was completed in February 2009.

Improvements arising from the Clarity Project broadly comprise the following:

• Identifying the auditor’s overall objectives when conducting an audit in accordance with ISAs;

• Setting an objective in each ISA and establishing the auditor’s obligation in relation to that

objective;

• Clarifying the obligations imposed on auditors by the requirements of the ISAs and the

language used to communicate such requirements;

• Eliminating any possible ambiguity about the requirements an auditor needs to fulfill; and

improving the overall readability and understandability of the ISAs through structural and

drafting improvements.

The Technical Directorate of ICASL, with the support of resource personnel from audit firms, is in the process of constituting Subcommittees for the Improvement Project under the “ISA Clarity Project”.

31

Seminar Series on Auditing Standards

A series of seminars on Auditing Standards was held recently.

The Sri Lanka Auditing Standards 2009 Bound Volume has been published and is now available for sale at the ICASL Library

Accounting StandardsThe following Standard is to be adopted by the Council

1 SLAS 43 Agriculture

Improvement Project II

The following Standards under Improvement Project II (in line with the International Financial Reporting Standards 2007 Bound Volume) have been adopted by the Council

1 SLAS 3 Presentation of Financial Statements

2 SLAS 5 Inventories

3 SLAS 9 Cash Flow Statements

4 SLAS 10 Accounting Policies, Changes in Accounting

Estimates and Errors

5 SLAS 12 Events after the Balance Sheet Date

6 SLAS 13 Construction Contracts

7 SLAS 18 Property, Plant & Equipment

8 SLAS 19 Leases

9 SLAS 20 Borrowing Costs

10 SLAS 21 The Effects of Changes in Foreign Exchange Rates

11 SLAS 24 Accounting for Government Grants and Disclosure

of Government Assistance

12 SLAS 25 Business Combinations

13 SLAS 26 Consolidated and Separate Financial Statements

14 SLAS 27 Investment in Associates

15 SLAS 28 Operating Segments

16 SLAS 29 Revenue

17 SLAS 30 Related Party Disclosures

18 SLAS 31 Interests in Joint Ventures

19 SLAS 34 Earnings per Share

20 SLAS 35 Interim Financial Reporting

The following Standards are to be reviewed

1 IFRS 1 First-time Adoption of International Financial

Reporting Standards

2 IFRS 4 Insurance Contracts

3 IAS 6 Exploration for and Evaluation of Mineral Resources

32

Improvement Project II ……./contd...

The following Standards under Improvement Project II (in line with the International Financial Reporting Standards 2007 Bound Volume) have been adopted by the Council

21 SLAS 36 Provisions, Contingent Liabilities and Contingent Assets

22 SLAS 37 Intangible Assets

23 SLAS 38 Non-current Assets Held for Sale and Discontinued Operations

24 SLAS 39 Share-based Payments

25 SLAS 40 Investment Property

26 SLAS 41 Impairment of Assets

27 SLAS 42 Accounting and Reporting by Retirement Benefit Plans

1 IAS 12 / SLAS 14 Income Taxes

2 IAS 19 / SLAS 16 Employee Benefits

3 IAS 32 Financial Instruments: Presentation

4 IAS 39 Financial Instruments: Recognition & Measurement

5 IFRS 7 Financial Instruments: Disclosures

The Statutory Accounting Standards Committee has made a decision to upgrade all Standards in line with the International Financial Reporting Standards 2009 Bound Volume under Improvement Project III in the year 2010. Hence the Standards adopted under Improvement Project II will not be gazetted or be applicable for the preparation and presentation of financial statements. The improvements made under Improvement Project II could serve to provide advance notice of changes to the existing Standards that would be incorporated in and continued with Improvement Project III.

In addition to the above, the following Standards will also be taken up under Improvement Project III:

Laughter the best medicine…

A Police Officer in a small town stopped a motorist who was speeding down Main Street.

“But, officer,” the man began, “I can explain”

“Just be quiet,” snapped the officer. “I’m going to let you cool your heels in jail until the chief gets back.”

“But, officer, I just wanted to say”

“And I said to keep quiet! You’re going to jail!”

A few hours later the officer looked in on his prisoner and said, “Lucky for you that the chief is at his daughter’s wedding. He’ll be in a good mood when he gets back.”

“Don’t count on it,” answered the fellow in the cell. “I’m the groom.”

33

Regional Standard-Setters Conference

Annual Report Awards 2009

Regional Standard-Setters Conference held at the Oak Room, Cinnamon Grand Colombo on 24th November 2009.

Overall winners of the Annual Report Awards Competition held at the Oak Room, Cinnamon Grand Colombo on 25th November 2009.

34

Global Scene

company has a structured hedging programme to ensure that it is 100 percent hedged during the current period and hedged up to 50 percent of its exposure for up to two years later. CFO Laura Wright says that the company plans the programme well in advance – establishes the required budget and builds up its positions. Using call options, fixed-price agreements and strike prices for the future, Southwest utilises the hedging methods to the best of its advantage.

No outsourcing

The option of outsourcing the hedging activity is available, what with many a company providing hedging services. But, financial analysts warn companies against using such services. A hedging plan should be tailor-made for each company, depending on the conditions specific to the company and the industry. According to Robert Brooks, Professor of financial management at University of Alabama, inappropriate hedging activities and non-competitive pricing can lead to companies incurring heavy losses. In fact, these losses can even run into six or seven figures for a single hedge.

Bring in the treasurer

A treasurer understands the financial position of a company the best. He has a clear idea about the risks facing the company and the steps, i.e., the hedging methods that can be best employed to minimise these risks. If a company decides to outsource hedging operations, treasurer is the person who should advise on what to outsource.

Matt McLaughlin, president, Midstream Partners LLC, a consultancy firm, says that before making a decision on the company’s hedging strategies, its Treasurer needs to be clear about the objectives of the company. How the company chooses to protect itself against risks, the steps it plans to take, the time periods involved, etc. are some of the factors that need to be considered. Once the company is clear on these issues, a decision can be taken on whether to outsource the hedging to an investment bank.

International Finance: Hedging is a Good Idea

Hedging is an important part of effective financial management for any business. It reduces the risks associated with holding an investment. Hedging is done using derivatives – call options, put options, short selling, futures, contracts, etc. These methods help reduce the volatility in a portfolio. Hence, a hedge is a kind of insurance for an investment against risk.

In detail

Though there are different kinds of derivatives available in the market, all of them provide similar benefits to a business. Companies can use Forwards, Futures, Swaps and Options to hedge their risks.

Forwards are deals whereby a party agrees to sell a particular commodity, financial instrument or foreign currency at a particular price on a specific future date.

Futures are similar to Forwards except that they are traded on an exchange. Thus, the terms of the contract are standardized. Futures have an advantage in that they eliminate the credit risks that are a part of the forwards contract. Swaps are also similar to Forwards contracts. But, the account settlement in case of Swaps is done on a regular basis, for example, at the end of every month. An option is defined as a contract that gives the holder “the right, but not the obligation to buy or sell a specific asset at a specific price.”

How hedge helps

Derivatives play an important role in the financial risk management of a company. For instance, a company that is dependent on large quantities of oil for its daily operations has to hedge itself against the volatile oil prices. Or else, the volatile global oil market would deal a heavy blow on its operation costs.

One such example is Dallas, US-based Southwest Airlines Co. The

Accounting standards

The past few years have witnessed many scandals surrounding hedging and accounting for hedging. Yet, hedging is still considered an effective and important part of risk management strategies.

The spate of accounting scandals in the US led to the strict implementation of accounting standards for hedging operations. Financial Accounting Standard (FAS) 133, which came into effect in 2001, deals with financial reporting of derivatives and hedging activities. In introducing this standard, the Federal Accounting Standards Board (FASB) brought about more transparency in accounting practices of companies.

The responsibility for following the standards in line with the guidelines is vested with Treasurers and Corporate Accountants. FAS133 is a very detailed standard and runs into several hundred pages. Often, it’s confusing to follow. However, the need for increased transparency in the accounting practices of companies has made it important for managements to follow the rules.

The accounts and auditing staff value the company’s hedging instruments complying with the FAS 133. Non-compliance can have adverse impact, with the hedging instruments failing to qualify for hedge accounting. FAS 133 stipulates that the company shows how effective its hedging instruments are, and to what extent they can set off the risks. The portion of the gain or loss that the derivative incurs to cover up the exposure is the “Effective portion” of the derivative.

If the hedging instrument does not qualify to be used in any accounting year, then the company has volatility in its financial results, since the gain or loss made on the derivatives would be accounted for in a different accounting period.

“The material above has been reprinted here with the kind permission of The Manage Mentor (www.themanagementor.com) - Asia’s first Knowledge Portal for Professionals”

Technical DirectorateThe Institute of Chartered Accountants of Sri Lanka

Tel/Fax: 2594118 (Direct), 2352000 (Gen), Email: [email protected]

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