The worst of the recession, it appears, is behind us as Indian companies have started delivering better results. Prima facie, profits of companies have improved since the beginning of the calendar year from a year ago. In most cases, that indeed may be the case; but the results of a few companies lead one to believe that the main driver behind spectacular profit numbers may be accounting rather than economics.
To recap, the ministry of corporate affairs (MCA), as per the recommendations of the National Advisory Committee on Accounting Standards (Nacas), suspended Accounting Standard (AS) 11 as of 31 March for a period of two years. Earlier, companies were expected to mark their underlying foreign currency, or forex, assets and liabilities to market and book any gains or losses to the profit and loss account. However, the suspension of the accounting standard has meant that companies only need to book a portion of such changes to the profit and loss account, while the remainder is booked to a special account on the balance sheet. Unfortunately, few listed companies publish their balance sheet every quarter though the earnings statement is released every quarter—a recipe for imbalanced information which can be misleading.
Several companies have—in their notes to earnings statements—stated that after the notification issued by MCA, they have changed their forex accounting policy. However, very few quantify the impact of this policy change on the income statement of the company.
Moser Baer declared a net profit of Rs42.9 crore in the quarter ended 31 March compared with a loss of Rs71.7 crore in the corresponding period a year ago, on the back of “strong cash flow from operations”, as its press release declared. However, a note to its quarterly press release states that consequent to accounting policy changes, the profit for the quarter is higher by Rs145.6 crore. So, if AS 11 hadn’t been suspended, the loss would have widened to Rs102.7 crore.
A more recent case is that of Tata Motors, which changed its accounting policy for forex items in the last quarter of 2008-09. In the June quarter of 2009-10, Tata Motors (stand-alone) reported a net profit of Rs514 crore, compared with Rs326 crore in the corresponding period last year.
A growth of 57.6% in net profit in the face of 7.5% deterioration in sales is, no doubt, an outstanding performance. However, a note to the statement explains that the Rs326 crore profit made last year would have been higher by Rs176 crore if the new accounting standard—that is, the suspension of AS 11—had been in place then. In effect, then, the net profit grew by a much smaller 2.4% and not an eye-popping 57.6%.
There is also the exceptional case of Tata Steel, whose profits would have been Rs1,067 crore instead of Rs790 crore for the first quarter of 2009-10 had it stuck to the previous accounting standard.
Investors are trying to decipher corporate performance to fathom the direction of economic growth. The shenanigan of suspending an accounting standard has unnecessarily changed the yardstick for measuring this performance, making the investor’s job that much more complicated.
So, which company’s profits have actually grown by how much? Did one read all the notes and understand them? How does one understand a note without any quantification of the accounting change? Most commentators knew this opacity was coming.
This confusion with numbers could have easily been avoided. Let’s hope for better judgement from the relevant authorities the next time companies come lobbying for changes to accounting standards.
Puranika Narayana Bhatta runs a finance and operations consulting firm in Bangalore. Comment at firstname.lastname@example.org