Calling for new digital accounting and financial reporting standards for companies and digital assets including crypto-assets

 

ASSOCHAM INTERNATIONAL VIRTUAL CONFERENCE ON FINANCIAL REPORTING AND CONTROL

 

KEYNOTE ADDRESS (Part I)

 

ON

 

RETHINKING FINANCIAL ACCOUNTING AND REPORTING

FOR COMPANIES IN THE DIGITAL AGE

 

SUBHASH CHANDRA GARG

ECONOMY, FINANCE AND FISCAL POLICY STRATEGIST AND FORMER FINANCE, ECONOMIC AFFAIRS AND POWER SECRETARY GOVERNMENT OF INDIA

(Guest of Honour)

 

 

Companies generate bulk of profits and also about half the gross value added in the economy

Raison d’etre of the business, as is commonly understood, is to earn profits for the owners by producing and distributing goods and services of value to its consumers. The gross value created by the businesses generate incomes for the workers and taxes for the Government, besides generating profits for the owners. Wages, taxes and profits, which make up the sum total of the GDP of an economy, all flow from the businesses.

Companies are the most prominent form of businesses. Globally, corporate profits are estimated to be around $10 trillion and corporate taxes around $2.5 trillion. Global economy is of the order of around $90 trillion. Global corporate profits thus make up more 10% of global GDP.

Size of Indian economy is of about $3 trillion. Government’s collections from corporation taxes is about $80 billion. Assuming 25% to be net effective corporate tax rate in India, the profits of companies in India should be around $300-$325 billion, roughly about 10% of GDP. The corporate profitability in India is thus similar to general global standards.

Companies in India contributed gross value added of Rs. 83.76 lakh crore in 2019-20, out of the total GVA of Rs. 184.61 lakh crores, generating a share of over 45% of India’s total value of goods and services produced. Corporations’ expenditure of Rs. 29.38 lakh crore, out of the total gross capital formation of Rs. 60.46 lakh crore in 2019-20, also amounted to 48.6% of total gross capital formation in India[1].

The rest of the economy- agriculture, small businesses in mining, construction, manufacturing and services- is highly informal and unorganised. Most of the organised sector GDP, wages, profits and taxes come from the companies.

Current accounting and financial reporting standards are for the bygone industrial era

The accounting and financial reporting standards mandated by the Government and/or the professional accounting bodies in India, for that matter, all over the world, are primarily meant for the companies, which were the growth engines of the industrial era. Present standards were thus meant largely for the industrial age. The paper based accounting and financial reporting system is also meant for serving the needs of that time.

There are two big developments relating to digital economy which call for transformation of these industrial era standards and which should make our accounting and financial reporting standard setters and regulators to take notice and initiate processes to rewrite the standards.

First, digitalisation has transformed services massively, including accounting and financial services. It is transforming manufacturing as well. Conversion of manual accounting system in electronic system is only a part of the process reforms. Accounting, financial reporting and auditing have to be very different in the digital age. There is thus urgent need for a complete digitalisation of accounting, financial reporting and auditing for the companies.

Second, the basket of assets companies own has been changing over last few years. Earlier the change was driven by intellectual property, biological resources and other non-tangible assets. Most of these assets have been recognised and standards developed therefore. Now, digital assets are emerging as the new competitive advantage and the stock of wealth. There is need for mainstreaming digital assets and also liabilities in the accounts and balance sheets of the companies.

Complete digital accounting, auditing and financial reporting for all companies

All large and many small companies are using the accounting and financial reporting software standalone or as part of the enterprise resource system to write their accounts electronically and generate their reports digitally. Audit is not developed that much and still uses tools of the manual system of accounting. Still, a substantial proportion of total active companies in India (a little over 1.3 million) maintain their accounts, fully or partially manually and furnish the returns in paper letters and formats, albeit mostly attached to the emails.

The regulatory and business environment is changing fast and becoming digitalised. Payments have become digital. For companies, making and receiving payments digitally, is the most convenient way in present times. Such a system also integrates well with accounting and banking. In a staggered manner, all GST registered businesses are moving towards generating invoices online. This has been transforming the purchases, production and sales accounting in digital mode. The day is not far off when all the invoices generated by the companies in the country could become part of a national invoices database like all bank accounts are part of one single bank account database created by UPI. When internet of things is digitally linking all machines in a vast digital network, it is quite easy to visualise all companies operating in a complete digital accounting and reporting environment and system.

There are two major asks for making Indian companies transform accounting, auditing and financial reporting in a fully digital mode.

First, like GST staggered mandate for moving toward online generation of invoices, all the 1.3 million odd companies in India should be mandated as part of a staggered programme to switch over to digital only accounting, auditing and financial reporting system. This will require outlawing manual accounts and auditing system for companies after a certain specified date.

Second, a comprehensive and functional digital accounting, auditing and financial reporting standard should be issued. This standard should lay down maintenance of accounts in a complete digital environment, with no paper or paper equivalent entering into the system anywhere. Present auditing system is based on sample audit techniques. Digital accounts and programmes allow universal vouchers auditing and collection of the required audit information by using the programmes. The standard should lay down the digital age auditing standards and practices which should be compulsorily made applicable for company audits. The digital accounting and auditing would enable generation of all regulatory reports and furnishing thereof in a fully digital mode. The whole process of financial reporting can actually be made fully machine in an automated programme mode.

While SEBI has a big influential role to play in making listed companies shift to digital only accounting and financial reporting, the real push will have to come from the Ministry of Corporate Affairs and ICAI. They are in charge of accounting, auditing and financial reporting standards and have control over all companies, listed or unlisted.

Taking digital assets, including crypto-assets, on board

Sale of a digital painting recently for $70 million created a big splash. Could an Indian company have bought this painting? If yes, how was it to be accounted for in the books of the company? Would any depreciation or appreciation permitted on it? If this painting was to be used for generating some revenue for the company, would that revenue be recognised as business income or some other income? The ensuring burst of digital assets are likely to raise these issues more and more.

Digital painting I spoke about was one of the many types of crypto-assets which are now mushrooming. Market capitalisation of ‘crypto-currencies’ has crossed $2 trillion and might soon cross India’s GDP. Digital programmes using blockchain technology and cryptography are generating numerous types of assets and businesses the world over. Some crypto-blockchain programmes, like bitcoin, seek to create currencies. Others like Ethereum build vast programming platforms for building blockchain/cryptography based services. There are others which offer different types of services.

While crypto-currencies have occupied largest eye-balls and have rightly raised the hackles of the government and regulators who have the sole authority to issue the currency/ legal tender, other crypto-businesses have quietly expanded their footprint by delivering real services and producing digital assets.

A very peculiar characteristic of these digital age crypto-businesses is creation of a crypto-token to express and divide the value of their total business. These crypto-tokens are used for rewarding the services rendered on the platform like mining etc. and also transferring value from one holder to another. Equating or valuing these crypto-tokens in official currencies has given speculative colour to these businesses, while these have been used much more purposefully for the intra-platform payments and transfers. There is no doubt that the companies would have to deal with and engage with the crypto-businesses increasingly in times to come.

For the crypto-businesses, the crypto-token they create is their passport to raise capital. They rest of the world subscribe to their capital/ initial coin offerings in their official currencies and, may be in times to come, in crypto-tokens issued by other crypto-businesses. Crypto-tokens issued by crypto-businesses are emerging as a significant asset class. For various reasons, sound or unsound, the Indian companies might also get interested in investing in crypto-tokens, which will then have to sit in their balance sheet as their assets.

It is also not quite unreasonable to think that some crypto-business might set up crypto-exchanges where the real sector companies can raise equity by issuing crypto-tokens or borrow on a loan crypto-business platform in crypto-tokens. As the stock exchanges of today allow companies to raise capital, both equity and debt, on their platforms and facilitate trading of their shares and debt securities in official currency today, the stock-exchanges of tomorrow might allow companies to raise capital and trading of their securities in crypto-tokens.

The crypto-assets are not the only conceivable form of digital assets. Many central banks are considering issuing official currency in crypto-currency mode. There can be other forms of digital assets like dematerialised currency or bonds or equities. The bouquet of digital assets are expanding. The possibility of raising digital liabilities is also expanding. The regulators need to have standards for accounting, auditing and reporting of digital assets and digital liabilities.

The standard setting and regulatory bodies have not taken good cognisance of this fast emerging digital assets and liabilities class. It is high time the MCA and ICAI takes note of these developments and initiate work on building standards for treatment of transactions in and treatment of digital assets and liabilities. It is also high time, all the sector regulators take note of crypto-assets and crypto-businesses and integrate them in their regulatory domain. The distinctive nature of this new class will require building appropriate risk recognition and containment standards as well.

Digital economy is at the centre of all the four transformational changes

Transformation of industrial economy into digital economy is at the centre of the two changes. Digital assets and digital modes of raising capital are going to be increasingly important in future. It is better to take note of it and start building standards and codes for digital assets and digital liabilities. Digitalisation is the force which would change all economic activities tremendously. It therefore makes eminent sense to take note of it and enable all companies to convert to digital only mode of account keeping and financial reporting.

---

[1] Data in this paragraph are from the National Accounts Statistics 2021