India’s biggest aluminium producer, Hindalco Industries Ltd, is planning to route the cost of buying Novelis Inc. through the balance sheet, rather than the usual practice of showing it in the profit and loss account.
It informed stakeholders through a stock exchange announcement that it would create a “business reconstruction reserve account”, which it would use to write off or adjust non-operating and extraordinary costs on the international acquisition, and expand in India.
The firm will create this account by drawing from the balance available in its securities premium account, where it had Rs4,268 crore at the end of March.
Prudent accounting norms dictate write-downs on an investment gone sour be reflected in the profit and loss statement. Recently, NYSE Euronext reported a loss for 2008 because it wrote down the value of its investment in Euronext.
But shrewd accountants in India have devised a way to take such losses to the balance sheet through a court-approved scheme. Since boards have approved the proposal and shareholders don’t usually object, courts have always allowed such schemes.
In the past, Tata Motors Ltd had offset its product development expenses with the credit in the share premium account, instead of amortizing the same in the profit and loss statement.
By doing this, companies hide the true profit or loss they have made in their businesses. Hindalco, for instance, lost a massive amount while refinancing its bridge loan due to the depreciation of the rupee. The $3 billion (Rs14,610 crore now) bridge loan was taken when the rupee was around 40 to a dollar, resulting in a liability of Rs12,000 crore on its books.
Last November, when the company had to repay it, the rupee had depreciated to around 50 to a dollar, taking its liability to Rs15,000 crore. At least $2 billion of this was raised in India, which would mean large losses at the consolidated level.
These losses, coupled with the write-down of goodwill, if any, will now only reduce the company’s net worth, but will not reduce its profit. Shareholders may not find it worthwhile to take this matter up in the courts, but perhaps the markets regulator should recognize such attempts by companies to hide losses.
It’s not that investors are unaware: The Hindalco stock is languishing at about Rs45 and now has a market capitalization of $1.5 billion, much lower than even what it had paid for Novelis. But that shouldn’t stop the regulator from insisting on fair accounting.
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