Case Study on SAIL (Window Dressing)

Written By: Yogin Vora on October 30, 2010 No Comment

Window Dressing done by “SAIL”

The annual report for 1997-98 reveals, the Rs 16,403-crore Steel Authority of India Ltd’s (SAIL)
bottomline is not worth its weight in steel. By resorting to complex accounting changes, and
despite 11 qualifications from 5 statutory auditors–as well as the venerable Comptroller &
Auditor-General of India (CAG) SAIL, transfigured net losses of Rs 354.08 crore into net profits
of Rs 132.99 crore in 1997-98.

The performance of SAIL the country’s largest steel producer was not good in the previous year.
Despite the recession, and even as it was buffeted by cheap imports, SAIL’s sales went up
marginally: from Rs 14,114.01 crore in 1996-97 to Rs 14,624.07 crore in 1997-98. But its net
profits plummeted from Rs 515.17 crore to Rs 132.99 crore on account of a Rs 374- crore
increase in interest costs and a Rs 104-crore increase in depreciation.

Even these meagre profits–which account for only 0.81 per cent of its sales–came from window-
dressing the accounts through write-backs and non-provisions. But a SAIL spokesperson
defended by saying that “Changes in accounts are for valid and justifiable reasons.” We now
look at the five contentious accounting changes made by SAIL:

Pre-commissioning expenses.

Until 1996-97, SAIL used to treat project expenditure incurred beyond the 6-month trial-run
period as deferred revenue expenditure, which was written off over the next 5 years. But, last
year, the company changed tack: it capitalised the entire expenditure on the modernisation of the
Durgapur (West Bengal) steel plant and the new hot-rolled coil plant at Salem (Tamil Nadu) with
retrospective effect. Thus, the company was able to increase its net profits by Rs 61.79 crore.

SAIL replied to this qualification by saying: “The company sought the advice of financial
experts, who stated that all expenses incurred in the trial-run period–without limiting to 6
months–till the assets concerned are ready for commercial production should be capitalised.
Accordingly, the expenditure during trial-run has been capitalised.” In doing so, SAIL is no
different from many other Indian companies that capitalise the entire expenses during the trial-
run time-frame.
That does not mean that the move isn’t opportunistic: by capitalising the entire expenditure, the
time over-run costs do not figure in the revenue account. And profits are, thus, not depressed.
Once a plant is ready, a 6-month trial-run period is adequate to make it fit for commencing
operations. If, for any reason, that period extends beyond 6 months, at least a part of the
expenses should get reflected in the revenue account. Which they aren’t.

Depreciation accounting

Until last year, SAIL used to fix the depreciation rates for assets–like earth-moving equipment,
automobiles, and so on–according to the estimated useful life of the assets, or by the rates as per
Income Tax laws. However, its depreciation rates in the current year have been changed to those
suggested in Schedule 14 of the Companies Act, 1956. As these rates are lower–and since the
change was made with retrospective effect from the date of acquisition of the assets–the
company wrote back Rs 109.83 crore of excess depreciation provided for in previous years in the
Profit & Loss (P&L) account.

Including the Rs 8.74-crore lowering of depreciation for 1997-98, Rs 118.57 crore accrued to the
company’s P&L account last year. Not only has the company artificially boosted its profits, the
change is against the accounting standards prescribed by the Institute of Chartered Accountants
of India (ICAI). According to the Accounting Standard (6)–which is a standard, and not
statutory–the impact of any change in the depreciation rate should be carried out on the residual
Book Value of the assets, and not for the re-computation of depreciation in the past. Says the
SAIL spokesperson: “It was decided to follow the depreciation rate according to the Companies
Act, as is being done by other players in the industry.” This is an age-old manipulation used by
corporate India.

Leave-Encashment liability.

In 1997-98, SAIL also changed the policy of providing for the leave-encashment liability for its
employees from an accruals basis to an actuals basis. Thus, it wrote back the provisions made in
the earlier years, resulting in an increase in net profits by Rs 85.39 crore. This is, again, against
the Accounting Standard (15) issued by the ICAI, which insists that such liability must be
provided for on an accruals basis.

The company’s explanation: “Leave is not a matter of right. As leave is meant to be availed of,
the employees have been advised to plan their leave in advance while in service, and also
immediately before superannuation. Liability towards leave encashment is recognised and
provided for only when the encashment is allowed by the management.” However, the labour
laws of the Government Of India stipulate that leave is the right of an employee, who also has
the right to encash leave by accumulating it. When you work, you earn leave. Just as one has the
right to get a salary, one also has the right to avail of the leave that he has earned.

Valuation of stocks.

SAIL has also inflated its income by changing the valuation methodology for its stocks. In a
break from the past, SAIL included the interest on funds borrowed for working capital as a part
of the cost in the valuation of finished and semi-finished stocks in 1997-98. According to the
auditors, this change in methodology, which is “not in accordance with the generally-accepted
norms of valuation,” resulted in an increase in SAIL’s profits by Rs 159.78 crore last year.

Adding interest cost to the valuation of stocks is against the spirit of the Accounting Standard
(2), which deals with the valuation of inventories. SAIL, however, argued that for production
planning, all elements of cost–including the interest on working capital–are taken into
consideration. The same logic had been used for the valuation of stocks.

Export incentives.

Also, SAIL changed the method of calculating its export incentives, which were, so far,
accounted for on a cash basis. In 1997-98, this was changed to an accruals basis, resulting in an
increase in profits by Rs 72.35 crore. SAIL explains that it did so because “export incentives are
available based on exports during the year. Accordingly, the benefits of exports incentive earned
during the year have been recognised in the accounts.” However, it also adds income which may
actually come in the next financial year for exports made in the current financial year.

Wage revisions.

Finally, SAIL’s auditors have also pointed out that the company has not made any provision for
a wage revision pending the finalisation of a long-term agreement with its employees. The
management argues that since the new wage agreement had not fructified, the financial impact
was not ascertainable. That is surprising since the earlier agreement expired 22 months ago, on
December 31, 1996. In fact, the CAG points out that SAIL has understated its employee
remuneration by not providing for Rs 194.48 crore.

Although it is not clear how the CAG has arrived at this figure, SAIL could have, as a matter of
prudent accounting practice, made a provision of, say, Rs 110 crore, which is 5 per cent of its
present annual wage bill of Rs 2,200 crore. By not doing so, the company is carrying over its
present expenditure to a future date, and, thereby, presenting a distorted picture of profitability. It
is sure that by not providing any money for the wage-revision liability, SAIL has artificially kept
its wage costs low for the year.

If all the accounting changes listed by the auditors–including the CAG’s figure of a wage-
revision liability of Rs 194.48 crore–are adjusted for in SAIL’s p&l account, the company would
have incurred losses of Rs 548 crore in 1997-98. And that represents a negative swing of nearly
Rs 1,000 crore from SAIL’s net profits of Rs 515 crore in 1996-97. Clearly, the chinks are
showing at India’s largest house of steel. And the worst may still be in the forging.

Profit and Loss Account for the year ended 31-3-1998.                            Rs. Mn.

Actual
Particulars As Shown
Period ended 03/98 03/98
No. Of months 12 12
Gross Sales 146,240.7 146,240.7
Excise Duty (19,149.9) (19,149.9)
Net sales 127,090.8 127,090.8
Other income 6,895.5 6172
Total income 133,986.3 133262.8
Raw materials 54,109.8 54,109.8
Stock adjustment (Inc)/ Dec (10,599.8) (9002)
Purchase of finished goods 2,712.3 2,712.3
Cost of material 46,222.3 47820.1
Employee cost 22,013.2 22013.2
Provision for wage 1944.8

revision
Power & fuel 14,684.8 14,684.8
Advertising/ promotion/ public 252.4 252.4
Freight & forwarding 6,047.4 6,047.4
Other expenses 20,142.0 20,142.0
Pre Commissioning 617.9
Expenses
Provision for leave 853.9
encashment
Cost of sales 109,362.1 114376.5
PBIDT 24,624.2 18886.3
Interest & finance charges 15,537.6 15,537.6
PBDT 9,086.6 3348.7
Depreciation 7,948.6 9046.9
PBT 1,138.0 (5698.2)
Provision for taxation 156.0 156.0
Extraordinary items/ Prior year adj. 347.9 347.9
Adjusted PAT 1,329.9 (5506.3)

Balance Sheet as on 31-3-1998

Period ended 03/98 03/98

No. of months 12 12

SOURCES OF FUNDS
Equity capital 41,304.0 41,304.0
Capital reserve 45.1 45.1
Share premium account 2,437.6 2,437.6
Profit & Loss/ General reserve 24,925.8 18089.6
Other reserves 16,867.3 16,867.3
Reserves and surplus 44,275.8 44,275.8
Net worth 85,579.8 85,579.8
Secured loans 89,006.8 89,006.8
Unsecured loans 111,139.3 111,139.3
Total debt 200,146.1 200,146.1
Capital employed 285,725.9 278889.7

APPLICATION OF FUNDS
Gross block 228,261.8 228,261.8
Accumulated depreciation (86,892.1) (86,892.1)
Capital work in progress 64,912.0 64,912.0
Total fixed assets 206,281.7 205,183.4
Investments 5,534.2 5,534.2
Inventories 75,893.5 74295.7
Sundry debtors 18,888.8 18165.3
Cash & bank balance 6,208.8 6,208.8
Total loans & advances 33,608.5 33,608.5
Sundry creditors/ Acceptances (82.4) (82.4)
Other liabilities (52,813.4) (52,813.4)
Provisions (8,485.9) (11284.6)

Net current assets 73,217.9 68097.9

Miscellaneous expenses 692.1 74.2
Capital deployed 285,725.9 278889.7

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Tags: Accounting Standard, Agreement, Assets, Auditors, Balance Sheet, CAG, Case Study,
Comptroller & Auditor - General of India, Corporate India, Depreciation Acoounting, Experts,
Export Incentives, Financial, ICAI, Industry, Inflation, Institue of Chartered Accountants of
India, Mordernisation, Profit & Loss, SAIL, Steel Authority of India Ltd's, Stocks, Valuation,
Wage, Window Dressing