Friday, October 21, 2011

Corporate Accounts: Accounting substandard

Companies are able to hide more than they reveal and auditors are strangely comfortable with that
There is an organisation called the Institute of Chartered Accountants of India (ICAI). It is supposed to set standards for fair accounting and transparency in communication of financial information to anyone who reads an audited annual report. It is also obliged to make written comments on any aspect that it finds unreasonable or not satisfactorily explained. Under law, chartered accountants are supposed to be appointed as auditors by shareholders of companies. In practice, it is the promoter who appoints them. At every annual general meeting, a routine resolution is approved by shareholders, appointing the auditor chosen by the promoter. The shareholder is not given any information about the audit firm, its capabilities or its size. In reality, the shareholder has no control or clue about who the company’s auditor is. 
Over the years, there has been total laxity and dilution of accounting standards in India, under the guise of ‘conforming’ to international standards. I have been analysing balance sheets for a long time and I can see 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, these are missing. If the company is somewhat generous, it may put up the subsidiary companies’ accounts on its website. This presumes that every shareholder has Internet access. However, the Web does not allow for a friendly read or enable you to move from page to page, quickly. Unless you sit down with a detailed paper report in your hand, you cannot see the accounting interconnections easily. 
Companies have abused the Internet to upload accounts in various formats that are difficult to read and engage in cross-reference. 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. I see that companies have managed to lobby with the government, in the garb of the ‘green’ movement, and move to electronic delivery of annual reports. I do hope this will not become mandatory because it is sheer nonsense. Unless one has a printed annual report, it is impossible to analyse the books of accounts. One would have to take a printout of the soft copies in any case—which undermines the whole ‘green’ concept. And don’t forget that companies do print fancy and glossy annual reports for giving to fund managers and the media. 
To explain what the disclosure standards have come down to, let me take the annual report of Reliance Industries Ltd (RIL), one of the most widely-tracked companies in India. I read from the P&L (profit & loss) account that the sales for the year 2010-11 were Rs2,48,641 crore. However, what product/s the company sold cannot be fathomed from the accounts. There is no schedule that gives the break-up of sales. Of course, one schedule mentions ‘production meant for sale’, listing different products and quantities, but not their value. Whether they were sold and what they contributed, the accounts do not tell me. The same is the case with purchases. Manufacturing & other expenses were Rs2,11,823 crore. The explanatory schedule gives one line saying ‘raw material consumed’ at Rs1,93,234 crore! Wonder what this is. The term is in the singular, so it must be one mighty raw material! A small item of Rs68 lakh of lease rent is detailed in this schedule but something that is thousands of times more in value is dismissed in one line!
If I go to the balance sheet, it is very impressive, indeed. Net worth of Rs1,51,548 crore. The net block of fixed assets is slightly larger than this. Investments made by the company are Rs37,651 crore. If I go to the ‘consolidated’ accounts, this figure drops to Rs21,596 crore. I see that the company has listed 142 ‘related parties’! It will take expert scanning and working to fathom how much money is invested in any associate, what stake the company has, etc. Again, different year-end dates for many subsidiaries/associates add to the confusion. There are three pages in small print which give ‘financial information’ of 120 subsidiaries! The size of the letters bothers me and I give up on reading the balance sheet. 
I am sure RIL discloses everything to the research analysts or on its websites. But the point is that 200+ pages of the mandatory financial disclosures are not enough to apprise you about the company’s operations. 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 ICAI to qualify and quantify the issue. It rarely does so. The balance sheet of Tata Steel also throws up an interesting issue as 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. Here is an excerpt:
“c) The Company has raised Rs1,500 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 classi´Čüed as ‘debt’ and the distribution on such securities amounting to Rs4.54 crores (net of tax) not considered in ‘Net Finance Charges’.”
When the company has an option to repay at the end of 10 years, how can it not be considered as debt for the first 10 years? Or is the company so sure of its abilities that it assumes the entire amount will never have to be repaid? And how can the interest on that 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 10 years, the entire debt can be converted into ‘other income’!
These two are only broad examples of what our disclosure standards have come to. Balance sheets are getting difficult to read and understand. This is surely not the road to increased transparency. The ICAI 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 (the Securities and Exchange Board of India) look into the accounting (sub)standards that are currently being followed with regard to listed companies. Left to the ICAI, we will never achieve any transparency in reporting.
R Balakrishnan

No comments:

Post a Comment