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When the going gets tough, the smart guys cook the books

ANANDH SUNDAR 
on 08 August 2011

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Warren Buffet famously said that an investor should have shot down the first aircraft that the Orwells flew, so that future investors would not have seen value destruction. In India, the same story of value destruction has emerged, but to compound the industry woes of economy dependence, LCC price wars, ATF etc; some companies are not above cooking the books. Following are some examples from the FY11 press releases/annual reports, for the financial reporting period ending Mar-11. The facts speak for themselves, and bring out why accounting risk is quite high in this sector, and for some business houses in particular.

1. Cherry picking accounting rules which allow favorable treatment-even before their final adoption:- Kingfisher airlines readily adopted a draft accounting standard, to reduce its losses by Rs 37 crores. This may seem good practice(early adoption) but the company does not show such enthusiasm for other proposed rules(like IFRS itself). And going by the management judgement on deferred tax assets, one must wonder the wisdom of this choice-despite the 'independent expert' view. If the expert was confident of its view, it should have allowed itself to be named. The note reads 'The Company has adopted the Exposure Draft on Accounting Standard - 10 (Revised) Tangible Fixed Assets which allows costs on major repairs and  maintenance incurred to be amortized over the incremental life of the asset..Had the Company not adopted this method of accounting, the loss before tax for the year and the loss after tax for the year would have been higher by Rs.3,726.83 Lacs  and Rs. 2,517.66 Lacs respectively..This revised accounting policy has been confirmed by an independent expert and in the opinion of the management, this accounting treatment has resulted in a fair depiction of the working results and the state of the affairs of the Company.'

2. Accounting for brought forward tax losses despite track record of losses:- Kingfisher Airlines in their Mar-11 press release announced that, Deferred Tax Asset is recognized on account of unabsorbed depreciation and business losses for the year ended March 31, 2011 aggregating to Rs. 49,341.80 Lacs. The management is of the opinion that there is a virtual certainty supported by convincing evidence against which such deferred tax will be realized. I do not know of any other Indian company, with comparable loss record/industry prospects, that has boldly felt that it will make enough  taxable profits in reasonable time to offset these losses.

3. Shifting depreciation method from WDV to SLM:- This typically results in lower depreciation expense and higher profits, atleast for the initial years. So Jet Airways discloses that . In order to reflect a more appropriate preparation/presentation of financial statements, the Company has changed the method of Depreciation on all owned tangible assets (including Simulators) other than Aircraft from Written Down Value Method to Straight Line Method w.e.f. 1st April, 2010 and the surplus arising from retrospective computation has been accounted and disclosed under Exceptional Items for the Year ended 31st March, 2011. This bottom line boost amounted to Rs 135 crores, as compared to PAT of 48crores loss.

4. Recording LCC investments at book value despite heavy equity erosion:- This is not unique to airlines, but even where they are not market leaders(Jet Lite has just 7% market share), they are very optimistic. For instance, Jet invested nearly Rs 3200 crores in Jet Lite, yet is not accounting for the value erosion. Note that the valuer is unnamed, also that mere expectation of turnaround without a stated timeframe, is used to defer loss recognition.  The justification reads as follows The Company has equity and preference investments aggregating to Rs. 164,500 lac in Jet Lite (India) Limited, a wholly owned subsidiary, and has advanced an interest free loan amounting to Rs. 1,52,951 lac as on 31st March, 2011. A reputed valuer has valued the equity interest in the subsidiary as on 31st March, 2011 based on its business plans, which supports the carrying value of such investment The Company continues to provide financial support to the subsidiary's operations to further such business plans and expects it to turnaround. Accordingly, the subsidiary's financial statements have been prepared on a "Going Concern" basis and no provision is considered necessary at this stage in respect of the Company's investments and loans outstanding from the said subsidiary.




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