e Study on SAIL (Window Dressing)

BY: YOGIN VORA ON OCTOBER 30, 2010 3 COMMENTS

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Window Dressing done by SAIL The annual report for 1997-98 reveals, the Rs 16,403-crore Steel Authority of India Ltds (SAIL) bottomline is not worth its weight in steel. By resorting to complex accounting changes, and despite 11qualifications from 5 statutory auditorsas 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 countrys largest steel producer was not good in the previous year. Despite the recession, and even as it was buffeted by cheap imports, SAILs 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 profitswhich account for only 0.81 per cent of its salescame from windowdressing 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 periodwithout limiting to 6 monthstill the assets concerned are ready for commercial production should be capitalised. Accordingly, theexpenditure 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 isnt 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 arent. Depreciation accounting Until last year, SAIL used to fix the depreciation rates for assetslike earth-moving equipment, automobiles, and so onaccording to the estimated useful life of the assets, or by the rates as perIncome 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 lowerand since the change was made with retrospective effect from the date of acquisition of the assetsthe 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 companys 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 statutorythe impact of any change in the depreciation rate should be carried out on the residualBook 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 companys 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 SAILs 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 costincluding the interest on working capitalare 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, SAILs auditors have also pointed out that the company has not made any provision for awage 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 auditorsincluding the CAGs figure of a wage-revision liability of Rs 194.48 croreare adjusted for in SAILs 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 SAILs net profits of Rs 515 crore in 1996-97. Clearly, the chinks are showing at Indias largest house of steel. And the worst may still be in the forging.