Question

Compare the company’s profitability using company GAAP and U.S. GAAP

Answer 1

Some of these major differences between US GAAP and Indian GAAP which gives rise to differences in profit are highlighted hereunder :

1.    Underlying assumptions:

Under GAAP, Financial statements are prepared in accordance with the principle of conservatism which basically means “Anticipate no profits and provide for all possible losses”.

Under US GAAP conservatism is not considered, if it leads to deliberate and consistent understatements.

2. Cash flow statement:

Under GAAP , inclusion of Cash Flow statement in financial statements is mandatory only for  companies whose share are listed on recognized stock exchanges and Certain enterprises  whose turnover for the accounting period exceeds Rs. 50 crore. Thus , unlisted companies escape the burden of providing  cash flow statements as part of their financial statements.

On the other hand, US GAAP (SFAS 95) mandates furnishing of cash flow statements for 3  years – current year and 2  immediate preceding years irrespective of whether the company is listed or not .

3.    Investments:

Under GAAP, Investments are classified as Current and Long term. These are to be further classified Government or Trust securities ,Shares, debentures or bonds Investment properties Others-specifying nature. Investments classified as current investments are to  be carried in the financial statements at the lower of cost and fair value determined either on an individual investment basis or by category of investment, but not on an overall (or global) basis. Investments classified as long term investments are  carried in the financial statements at cost. However, provision for diminution is to be  made to recognise a decline, other than temporary, in the value of the investments, such reduction being determined and made for each investment individually.  

Under US GAAP ( SFAS 115) ,  Investments are required to be segregated in 3 categories i.e. held to Maturity Security ( Primarily Debt Security) , Trading Security and Available for sales Security and should be further segregated as Current or Non current on Individual basis.  Debt securities that the enterprise has the positive intent and ability to hold to maturity are classified as held-to-maturity securities and reported at amortized cost. Debt and equity securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities and reported at fair value, with unrealised gains and losses included in earnings. All Other securities  are classified as available-for-sale securities and reported at fair value, with unrealised gains and losses excluded from earnings and reported in a separate component of shareholders' equity.

4. Depreciation:

Under the GAAP, depreciation is provided based on rates prescribed by the Companies Act, .  Higher depreciation provision based on estimated useful life of the assets is permitted, but must be disclosed in Notes to Accounts.( Guidance note no 49) . Depreciation cannot be provided at a rate lower than prescribed in any circumstance. Similarly , there is no compulsion to provide depreciation at a higher rate, even if the actual wear and tear of the equipments is higher than the rates provided in Companies Act. Thus , an Indian Company can get away with providing with lesser depreciation , if the same is in compliance to Companies Act 1956. Contrary to this,

under the US GAAP , depreciation has to be provided over the estimated useful life of the asset, thus making the Accounting more realistic and providing sufficient funds for replacement when the asset becomes obsolete and fully worn out.

5. Foreign currency transactions:  

Under GAAP, Forex transactions ( Monetary items ) are recorded at the rate prevalent on the transaction date .Year end foreign currency assets and liabilities ( Non Monetary Items) are re-stated at the closing exchange rates. Exchange rate differences arising on payments or realizations and restatements at closing exchange rates are treated as Profit /loss in  the income statement.   Exchange fluctuations on liabilities incurred for fixed assets can be capitalized.

Under US GAAP (SFAS 52), Gains and losses on foreign currency transactions are generally included in determining net income for the period in which exchange rates change unless the transaction hedges a foreign currency commitment or a net investment in a foreign entity . Capitalization of exchange fluctuation arising from foreign liabilities incurred for acquiring fixed assets does not exist. Translation adjustments are not included in determining net income for the period but are disclosed and accumulated in a separate component of consolidated equity until sale or until complete or substantially complete liquidation of the net investment in the foreign entity takes place . US GAAP also permits use of Average monthly Exchange rate for Translation of Revenue, expenses and Cash flow items, whereas under Indian GAAP, the closing exchange rate for the Transaction date is to be taken for translation purposes.

6. Expenditure during Construction Period:

As per the GAAP (Guidance note on ‘Treatment of expenditure during construction period' ) , all incidental expenditure on Construction of Assets during Project stage  are accumulated and allocated to the cost of asset on completion of the project. Contrary to this, under the US GAAP (SFAS 7) , such  expenditure are  divided into two heads – direct and indirect. While, Direct expenditure is accumulated and allocated to the cost of asset, indirect expenditure are charged to revenue.

7. Revaluation reserve : Under GAAP, if an enterprise needs  to revalue its asset due to increase in cost of replacement and provide higher charge to provide for such increased cost of replacement, then the Asset can be revalued upward and the unrealised gain on such revaluation can be credited to Revaluation Reserve ( Guidance note no 57). The incremental depreciation arising out of  higher book  value may be adjusted against the Revaluation Reserve by transfer to P&L Account.  However for window dressing some promoters misutilise this facility to hoodwink  the shareholders on many occasions.

US GAAP does not allow revaluing upward property, plant and equipment or investment.

8. Extraordinary items, prior period items and changes in accounting policies:

Under   GAAP, extraordinary items, prior period items and changes in accounting policies are disclosed without netting off for tax effects .

Under US GAAP (SFAS 16) adjustments for tax effects are required to be made while reporting the Prior period Items.

9.   Capital issue expenses:
Under the US GAAP, capital issue expenses are required to be written off when incurred against proceeds of capitals,

whereas under GAAP , capital issue expense can be amortized or written off against reserves.

10. Proposed dividend:

Under GAAP , dividends declared are accounted for in the year to  which they relate. For example, if dividend for the FY 1999-2000 is declared in Sep 2000 , then the corresponding charge is made in 2000-2001 as below the line item . Contrary to this ,

under US GAAP dividends are reduced from the reserves in the year they are declared by the Board. Hence in this case under US GAAP , it will be charged  Profit and loss account of 2000-2001 above the line.

11. Employee benefits: Under GAAP, provision for leave encashment is accounted based n actuarial valuation. Compensation to employees who opt  for voluntary retirement scheme can be amortized over 60 months.

Under US GAAP, provision for leave encashment is accounted on actual basis. Compensation towards voluntary retirement scheme is to be charged in the year in which the employees accept the offer.