Another bottom line window

Seldom is an accounting book not soporific. For an exception that proves this, pick up Accounting & Analysis: The Indian Experience, 2006 (A&A), the just-released third edition published by Global Data Services of India (GDSIL), a subsidiary of rating agency CRISIL, dedicated to the analysis of corporate accounts. But for its academic-sounding title and the slightly formidable size, it could well pass off as a thriller for someone whose reading list ranges from annual reports to investment house handouts.

The bottom line of A&A is that reported net profits of companies are often higher than what an analyst should consider real net profits. Writes Madhu Dubhashi, CEO, GDSIL, in the foreword: "It is our endeavour to present all numbers in a standardised format that is simple and easy to understand."

Though companies may play by the rules as set by accounting standards and guidelines, differences of opinion do crop up between companies and their auditors, and between companies/auditors and analysts, and most of these relate to how or how not to treat/classify an item on the account sheets. The reason for these differences, according to GDSIL's analysts, is that, "accounting standards prescribe guidelines as well as rules for accounting but, occasionally, personal judgment is required while drawing up the accounts".

To reflect a company's true finances, GDSIL has reclassified these grey areas in the accounts of inflows and outflows in a standardised format. Investors will find this book an eye-opener. Since a company's net profit and resultant earnings-per-share by the GDSIL reclassification are different from the figures it reports, its price-earnings (P/E) multiple metric, especially the way it appears in investment publications, too needs to be revised for the purpose of making an investment decision.

Reading A&A helps you find your own way round these numbers in minute detail. What do accountants do that analysts do not approve of? Plenty, it turns out.

Companies change their inventory valuation method or depreciation methods, which cause an impact on profits. Bhushan Steel, for instance, changed its depreciation accounting policy to adjust the prior years' depreciation of Rs 33.99 crore against the "general reserve" in 2002-03, but GDSIL routes it through the "profit-and-loss" (P&L) account. This shift in perspective alters the bottom line.

Some companies have used their reserves to write off substantial expenses, which should have passed through the P&L account. Century Textiles adjusted an impairment in book value of fixed assets of Rs 72.59 crore and deferred tax liability of Rs 40.16 crore, in 2004-05, against "general reserves" and "security premium account", respectively. Asset impairments, in fact, are a favourite to keep off the P&L. For example, Ballarpur Industries adjusted impairment in the value of assets of Rs 44.35 crore against "general reserves" in 2004-05, which GDSIL deducts from the P&L account.

Companies also routinely write off bad debts and miscellaneous expenditure from reserves. In 2004-05, Tata Motors adjusted Rs 334.55 crore on account of premium on early redemption of non-convertible debentures, foreign currency convertible notes (FCCN) issue expenses and provision for premium on FCCN redemption, all against the "security premium account".

A&A also highlights the trend of companies giving up the practice of appending the accounts of subsidiaries to their annual reports. So a loss-making company could make profits from dividends and interest income from subsidiaries, with little reported to help study the details. On loss-making subsidiaries, A&A believes, "It is possible that dividends and interest may have been paid out of additional investments by the parent company." So what looks hunky-dory may not quite be.

Companies also capitalise interest on fixed assets before commercial production begins. This distorts the true value of fixed assets, and results in understatement of expenses in the P&L account.

In all, A&A's third edition has analysed the financial reports of over 500 companies, and has added a new chapter on "Human Resources Accounting". It does get technical in parts while quoting chunks of sentences from annual reports, but is generally readable. While it uses some case studies of earlier years, there are enough examples of 2004-05 accounts to make the book relevant to the current investor.

Besides the regular chapters on investments, inventory, intangibles and net worth, it also looks at liabilities outside the balance sheet, employee stock options, cash mergers and acquisitions. The table at the end on the difference between profits seen from differing perspectives is particularly handy. This book should serve as a desktop ready-reckoner for anyone who must make sense of corporate figures. It is a treasure chest.

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ACCOUNTING & ANALYSIS
THE INDIAN EXPERIENCE 2006

GDSIL publication
Price: Rs 3,500;
add Rs 2,500 for Volume II