Corporate Front: Balance-Sheet Analysis , Did SAIL Smelt Its Profits in its Furnaces?

CORPORATE FRONT: BALANCE-SHEET ANALYSIS
Did SAIL Smelt its Profits in its Furnaces?

Hardly, as write-backs and non-provisions helped the steel major report net profits of Rs 132.99 crore in 1997-98.

By Dilip Maitra

It has been smelting profits. But, as its 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)--Arvind Pande, 51, the CEO of SAIL, transfigured net losses of Rs 354.08 crore into net profits of Rs 132.99 crore in 1997-98.

Sure, SAIL, the country's largest steel producer, had it bad last 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. Defends a SAIL spokesperson: "Changes in accounts are for valid and justifiable reasons." BT examines 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 replies 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." Counters a Mumbai-based chartered accountant: "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. Says the human resources chief of a Bangalore-based company: "The laws are clear: when you work, you earn leave. Just as you have the right to get a salary, you also have the right to avail of the leave that you have 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.

Agrees the chartered accountant quoted earlier: "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, argues that for production planning, all elements of cost--including the interest on working capital--are taken into consideration. The same logic has been used for the valuation of stocks. Adds the spokesperson: "However, interest on capitalised projects continue to be charged to revenue only."

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. Points out the chartered accountant: "I am sure that by not providing any money for the wage-revision liability, SAIL is artificially keeping its wage costs low for the current year." Admits the SAIL spokesperson: "A wage agreement, once finalised, may have some linkage on production, profitability, productivity, and other parameters, and, as such, there could be many variants."

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.

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