Indian Annual Reports: Facts or fiction? With nearly 50% of Indian stocks failing to deliver positive returns over the last 20 years, there is more to Indian stocks than meets the eye. Whilst some of these firms may indeed have failed to deliver on genuine business grounds, several of these companies never intended to benefit minority shareholders in the first place. Before the annual report deluge for FY13 begins, we dig into our forensic accounting knowledge bank to give you case studies of how to navigate through camouflaged annual reports. We have repeatedly pointed out over the last three years the vital importance of accounting quality in shaping investment returns. Our annual accounting thematic, our proprietary forensic accounting model and our hundreds of bespoke accounting projects give us a wealth of knowledge when it comes to understanding how certain corporates in India flatter their books. In this note, before the FY13 Annual Reports start pouring in, we help investors identify the most popular accounting tricks that corporates use to mask the true health of their businesses. We provide ’real life’ examples of how various firms have used these aggressive policies in India. The caveat is that the use of such accounting policies is a red flag but not necessarily indicative of financial misdemeanour or fraud. Aggressive accounting policies highlighted in this note Revenue recognition policies: Some ways to spot aggressive revenue recognition policies include ‘% change in receivables/ % change in revenues‘ and ’operating cash flow growth/operating profit growth‘. We look at the specific cases of ICSA, Godrej Properties and Unitech in this note. Provisioning: Provision for doubtful debts and provisioning coverage ratio (in the case of banks) are often manipulated to help boost PBT. We look at the practices of Bajaj Electricals & some Indian banks for insights on this front. Auditor & the Auditor’s Report: Frequent changes in auditors and qualifications made/issues raised by the auditors should be carefully analysed as reflected in our case studies on Arshiya International and Lanco Infra. We also look into auditor’s remuneration using Crompton Greaves, CESC and JSW Energy as case studies Related Party Transactions: Related party transactions not executed at arm’s length need careful scrutiny as we discuss in the case of Crompton Greaves. Cash Yield: A sub-par cash yield may imply either non-operating income being booked as revenues or the cash & marketable investments figure on the balance sheet being misstated. Arshiya International as well as Geodesic and Tanla Solutions are interesting case studies. ESOPs accounting & fee income accounting for banks: The cost associated with ESOPs is typically not properly reflected in a bank’s P&L, thus inflating reported profits. Likewise, fee income, both fund-based and nonfund-based, can be accounted for in aggressive ways to flatter PBT. We see both of these aggressive practices at play in the top private sector banks. Capitalising R&D costs: By capitalising R&D costs, companies can defer its recognition as expense on the P&L; we turn to the case of Tata Motors (JLR). Pension accounting: By adjusting the various assumptions used in estimating pension expense for a period, a company can flatter its rep
Posted on: Fri, 14 Jun 2013 05:34:22 +0000
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