R Balakrishnan
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
classified 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.
The author can be reached at balakrishnanr@gmail.com
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
classified 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.
The author can be reached at balakrishnanr@gmail.com
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