Saturday, October 15, 2011

Shattered Accounting

(This was published in the latest issue of Moneylife) There is a body called the “Institute of Chartered Accountants of India” (ICA). It is supposed to set standards for fair accounting, transparency in communication of financials to anyone who reads an audited annual report, apart from being obliged to make written comments on any aspect that they find unreasonable or not satisfactorily explained. In law, they are supposed to be appointed by the shareholders. In practice, it is the promoter who appoints and at every AGM there is a routine resolution that is approved by the shareholders. The shareholder is not given any information about the audit firm, its capabilities or its size. The shareholder in reality, has no control or clue about who his auditor his. Over the years, there has been total laxity and dilution in accounting standards in India, in the guise of ‘conforming’ to International Standards. I have been analysing balance sheets over time and I can see the disclosure standards falling dramatically. Let me start with subsidiary companies. In the past, the annual report would have the full accounts, with schedules, of the subsidiary companies. Today, it is missing. If the company is somewhat liberal, it may put up the subsidiary companies’ accounts on its websites. This presumes that every shareholder has internet access. However, unless you sit down with a detailed paper report in your hand, the net does not allow one for a friendly read or enable you to move from page to page, quickly. Companies have abused the internet to upload accounts in various formats that are difficult to read and engage in cross references. Now, one understands that there is a move to make reporting in one uniform language, but it seems unlikely that things will get any better. Why not continue with the practice? I see that the companies have managed to lobby the government, in the garb of ‘green’ movement and move to electronic delivery of annual reports. I do hope that this will not be mandatory. I still love the old fashioned printed annual report. To tell you what the disclosure standards have come down to, let me take the annual report of Reliance Industries Limited, one of the most widely followed companies in India. I read from the P&L account that the sales for the year 2010-11 were Rs.248641 crores. However, what product/s the company sold cannot be fathomed from the accounts. There is no schedule that gives the break-down of the sales. Of course one schedule gives “production meant for sale” listing different products and quantities, but no value. Whether it was sold and what it contributed, the accounts do not tell me. Same is the case with purchases. Manufacturing & other expenses were Rs.211823 crores. The explanatory schedule gives one line saying “Raw Material Consumed” Rs.193234 crores! Wonder what it was? The language used is in the singular, so it must be one mighty raw material indeed! A small item of Rs.68 lakh of lease rent is detailed in this schedule but something that is ninety percent, is dismissed in one line! If I go to the balance sheet, it is very impressive indeed. Net worth of Rs.151548 crores! The net block of fixed assets is slightly larger than this. Investments made by the company is Rs.37,651 crore. If I go to the “Consolidated” accounts, this figure drops to Rs.21596 crores. I see that the company has listed 142 ‘related parties’! It will take expert scanning and working to fathom out how much money is invested in any associate, what stake the company has etc., Also, different year end dates for many subsidiaries / associates add to the chaos. There are three pages in small print which give ‘financial information’ of 120 subsidiaries! The print size bothers me and I give up on the balance sheet. I am sure that RIL discloses everything to the research analysts or on its websites. But the fact of the matter is that in 200 plus pages, the financial disclosures that are mandatory, are not enough to tell you what the company does. This is so different from the past, when there would be detailed schedules from which one could work out the unit costs, unit realisations etc., Today, in the name of saving on postage, printing etc, reporting standards have gone to the dogs. About accounting standards, the less said the better. Companies are allowed to follow different standards if they go to a court of law. Even if they do, it should be the job of ICA to qualify and quantify the issue. They rarely do. The balance sheet of Tata Steel also throws up an interesting thing in so far as accounting standards are considered. The notes to the accounts (page 160 of the annual report) show an ingenious accounting of the interest on ‘perpetual ‘debentures. “c) The Company has raised Rs 1,500 crores through the issue of Hybrid Perpetual Securities in March 2011. These securities are perpetual in nature with no maturity or redemption and are callable only at the option of the Company. The Distribution on the securities, which may be deferred at the option of the Company under certain circumstances, is set at 11.80% p.a., with a step up provision if the securities are not called after 10 years. As these securities are perpetual in nature and ranked senior only to share capital of the Company, these are not classified as ‘debt’ and the distribution on such securities amounting to Rs 4.54 crores (net of tax) not considered in ‘Net Finance Charges’.” When the company has an option to repay at the end of ten years, how can it not be considered as not debt for the first ten years? Or is the company so sure of its abilities that it assumes the entire amount to be never repaid? And how can the interest on that not be classified as something else? The company distorts its financial cover ratios if it does not include the amount under interest. Who knows? Maybe after ten years, the entire debt can be converted in to ‘other income’! The other thing that is happening in the name of ‘green’ or ‘eco friendliness’ is the emailing of balance sheets. This is a retrograde move. Unless I have a printed annual report, it is impossible for me to analyse a balance sheet. I would have to take a printout of the soft copies in any case. And the companies do print fancy and glossy annual reports for giving to the fund managers and the media. The above are two broad examples of what our disclosure standards are coming to. Balance sheets are getting difficult to read and understand. This is surely not the road to increased transparency. The ICA seems to be on a mission to help promoters to bring in opacity in the only formal communication that is made to the shareholders. And to think that under law, it is the shareholders who appoint the auditors! I would urge that SEBI look in to the accounting (sub)standards that are currently being followed with regard to listed companies. The ICA ought not to be trusted to bring transparency in reporting. R Balakrishnan September 16th, 2011


Arun said...


Just 1 elemental question regarding your analysis of Tata Steel`s balance sheet.When the interest payable on the 1500Crs hybrid perpetual securities is 11.5% pa, how come Tata Steel pays only Rs 4.5 Crs?


Frustrations Amalgamated said...

Dear Arun,
The bonds were issued in March 2011. I guess the interest would be for a few days in the year. Hence this low number.
regards and thanks for the comments.