Profiting from new accounting standards
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Mumbai: Indian companies have just reported their first set of results under a new set of accounting standards. The norms have resulted in significant changes to how some of the country’s largest companies report their performance. And it is good news so far, with profits higher and finance costs lower.
Audit and consulting firm KPMG looked at companies in the Nifty 100 that had declared June quarter results by 31 August. Its analysis showed that quarterly net profit was up by Rs2,667 crore for the companies. That was 4.55% higher than what they would have reported under earlier accounting norms.
The June quarter marked the first set of results after the new accounting standards came into effect this year. Companies were required to transition from the current accounting regime called GAAP (or Generally Accepted Accounting Principles). Authorities now require them to follow what are called the Indian Accounting Standards Rules, 2015, or IndAS Rules.
The June 2015 Indian GAAP numbers have been compared with the June 2015 IndAS numbers (given with the June 2016 IndAS financials). The quarter to June 2015 is the only period for which both Indian GAAP and IndAS financial information is available. From the June 2016 quarter, only IndAS information will be available.
The new norms are in line with the International Financial Reporting Standards which are followed by more than 100 countries across the world today. The new standards aim to increase transparency and provide a clearer picture of companies’ activities, according to experts.
All listed and unlisted companies with a net worth of Rs500 crore or higher were to move to the new accounting rules by 1 April 2016. This will apply to all listed companies and unlisted ones with a net worth of Rs250 crore from 1 April 2017. It will apply to financial institutions like banks and non-banking financial companies from 1 April 2018.
The Nifty 100 represents the top 100 companies by market capitalization on the Nifty 500. It accounts for 77% of the free float market capitalization of companies listed on the National Stock Exchange as of 31 March 2016. Free float capitalization represents shares of a company held in public hands. Banks, insurance and financial sector companies were excluded because IndAS does not apply to them yet. A total of 59 companies were considered.
A total of 41 companies recorded gains in net profit on account of the new norms. Only 18 showed a decline. More than a third reported a net profit change because of forex fluctuations. They accounted for 35.2% of the total profit impact, according to KPMG’s analysis. This would mean that a big chunk of the increase in profits is on account of favourable forex fluctuations. This also means that this tailwind could turn into a headwind if currency swings catch companies on the wrong foot.
Overall profitability was also positively impacted at companies that made changes to how they amortize factors like goodwill. Goodwill is how a company accounts for the excess money that it pays for acquiring an asset over and above its fair value. The earlier accounting standards required this to be amortized. This is no longer the case under IndAS, where goodwill is only tested for impairment (an exercise to basically see if it is still worth the money paid for it), and not amortized. Some companies have also reversed their earlier amortization of goodwill, according to the KPMG analysis, which has also added to the profit numbers.
A measure of operational profitability called Ebitda (or earnings before interest, tax, depreciation and amortization) was up 6.68%. Ebitda has been calculated after other income. It was 8.22% before other income. This meant that the companies reported higher profits from their core operations too, under the new norms. The Ebitda figure came in at Rs1.21 trillion. The figure is Rs7,565 crore higher than Rs1.13 trillion under Indian GAAP.
Finance costs were down 2.82% on an overall basis.
Most companies saw finance costs go up (34 out of 59 showed a total increase of 4.4%). They were unchanged for 11 companies but 14 saw a drop, and the magnitude of the fall for these 14 was 25.2%.
This has resulted in an overall decline in finance costs for the sample companies. The sharp fall is on account of the way joint ventures are treated under the new norms.
Joint venture finance costs also found a place on the profit and loss statement under the older regulations. But the new accounting standards don’t result in a proportionate consolidation of finance costs. So money which would earlier have been deducted as finance costs, now is not. This increases profits.
“In my assessment, the financing costs have gone down and may continue the same trend,” said Navin Kulkarni, head of equity Research at PhillipCapital (India) Pvt. Ltd.
The caveat to all the analysis included herein is that some companies have provided results on a stand-alone basis, without considering the impact of their subsidiaries on their results. Others have provided a consolidated figure. There is an absence of a common stand versus stand-alone under IndAS. However, since all companies have not uniformly provided consolidated figures or stand-alone figures, the aggregate number is a mix of the two. The above numbers can be seen to be indicative since companies have not followed a common format.
Other relaxations allowed by the regulator also made a regular and timely analysis slightly difficult.
The Securities and Exchange Board of India made relaxations which allowed companies more time to report numbers for the latest quarter. Their timeline for submitting results was extended by one month (14 September 2016 for the June quarter results).
Audit or limited review requirements were relaxed. Companies were told to make the disclosure that the results have not been subjected to scrutiny. In addition, they were to add that “the management has exercised necessary due diligence to ensure that the financial results provide a true and fair view of its affairs”.
Meanwhile, the effect of disclosures under new norms is also seen on the companies’ revenues.
The revenue for the companies under consideration was Rs6.88 trillion under the new norms. This is 3.11% or Rs20,745 crore higher than the Rs6.67 trillion under the old norms. Only 23 out of the 59 companies recorded an increase in revenue. However, their gains offset the losses by 30 companies that recorded a revenue decline. Six had no change.
A 29 June Kotak Securities Ltd’s institutional equities strategy report noted likely changes including higher revenue. This is because the number will be reported including components like excise duty. Such changes were expected to have some impact on Ebitda margins.
“It may distort reported Ebitda margin though, as historically the Street has computed Ebitda margin on net revenues/sales (excluding excise duty),” said the Kotak report authored by analysts Sanjeev Prasad, Akhilesh Tilotia and Sunita Baldawa.
Thirty companies reported lower taxes (down 11.7%). Twenty-eight showed a total gain of 3.6% while one remained unchanged. Taxes were down 1.43% on an overall basis for the 59 companies under consideration.
Overall forex fluctuations and income taxes had the biggest impact on profitability. They accounted for over 50% of the adjustments to profits that were made under the new norms. Changes on account of the valuation of financial instruments and property, plant and equipment also had an impact. They accounted for over 15% of the adjustments.
Sectors whose profits were impacted by tax considerations include pharmaceuticals, metals, and oil marketing and distribution. Forex fluctuations impacted the commercial vehicles segment the most.
The biggest change on revenue recognition among the major sectors was for the cars and utility vehicles segment, where it accounted for 39% of the change in profit. Absolute values for both decreases and increases were considered while calculating the impact of the new norms on a sectoral basis.
The biggest absolute impact of the new accounting standards was in the commercial vehicles segment. It saw the highest sectoral impact for the companies under consideration, largely driven by favourable forex fluctuations. This was followed by pharmaceuticals on account of changed accounting for taxes. Other sectors which gained on profit include electric utilities, oil marketing and distribution companies, and those involved in the agrochemicals business
It is difficult to say how trends may shape up in the days ahead.
“...It is too soon to say that whether this trend will continue as these are basic numbers and an analysis of balance sheets of companies would reflect a truer picture,” said Sanjiv Bhasin, executive vice- president(markets) at IIFL Holdings Ltd.
While the balance sheet may reflect some of the adjustments referred to above, the disclosures may not be as detailed as one would expect in relation to the annual accounts. In particular, companies are mandatorily required to publish the transition date (1 April 2015) balance sheet reconciliation only with the March 2017 annual results. Accordingly, a close eye will have to be kept on what information companies publish voluntarily with their September 2016 results; it’s quite likely that the entire impact may be understood only once the year-end financial statements are published, according to KPMG.
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What is clear however, is that investors can expect to know better what their companies are up to under the new standards. There is less room for obfuscation and ambiguity. This can have tangible benefits because more transparent accounting is held to translate into better price discovery. Shareholders are able to better value companies, and less likely to discount for uncertainty. This means that companies which are doing less well will be more accurately marked down. And valuations will improve for companies which are doing better.
However, there is more that can be done.
KPMG points out that an increase in the quantum of guidance addressing specific issues may help make financial reporting practices more uniform. However, care needs to be taken to ensure that this guidance is not inconsistent with globally accepted practices or guidance.
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Operationalizing a strong financial reporting oversight body to ensure quality and consistency in financial reporting across all companies, with strong monitoring and enforcement mechanisms would help. The National Financial Reporting Authority is designed to be a regulatory authority for accounting and auditing standards. It is in the process of being set up.
Investors can hope for cleaner numbers when it is in place.
Sapna Agarwal in Mumbai, Amrit Raj in New Delhi, Madhurima Nandy in Bengaluru and Viswanath Pilla in Hyderabad contributed to this story.