The Item Behind The Numbers

Corporate India seems to be in fine fettle, if you go by the earnings figures reported by companies for the last quarter. Estimates would suggest that revenues are higher than last year by almost 15 per cent, while profits are higher by 22 per cent. But to look at only bottomlines or toplines as a barometer of corporate performance could be dangerous. Much is hidden outside these lines, in the notes to accounts. The numbers in the financial statements can be swayed by how a company chooses to account for any particular item of revenue or expenditure, and there is enough of scope for convenient interpretation.

Take for example the case of two power companies, Tata Power and Adani Power, which got the same relief from their regulator in February this year. The Central Electricity Regulatory Commission allowed both companies to collect a higher amount of tariff retrospectively from their consumers. But if you looked at the profit and loss (P&L) accounts of both companies, you would be surprised.

Adani Power has recognised the entire amount it was entitled to collect, around Rs 1,800 crore, as revenue in that very same quarter, fourth quarter of FY14. On the other hand, Tata Power shows none of the Rs 1,100 crore it will be collecting from customers over this period as revenue. Extremes in accounting? Literally, yes.

Prudential accounting requires that contingent revenues be recognised when there is virtual certainty regarding its realisation, says Yogesh Sharma, partner at Grant Thornton. But how do you define ‘virtual certainty’? Let’s say you have a court order giving you a right to collect an amount, which the other party has not challenged through an appeal, or even better, has begun payments, then there is a case for recognition of revenue.

But rarely does the other party cave in so meekly, especially when the amounts involved are large. So an appeal is filed. What does the company winning the order do? They turn to the lawyers. If a lawyer certifies that even though the other party has gone on appeal, the company has a good case, and is certain to win, then one may go ahead and record the revenue, says Sharma. This is what Adani seems to have done.

Of course, that path is ridden with dangers. A few years ago, Essar Oil showed as revenue tax breaks that were due from the Gujarat government regarding the Vadinar oil refinery it had set up, after it had a favourable order from the Gujarat High Court. The government, however, contested that order, claiming that the refinery was not set up within the prescribed time. On appeal, the Supreme Court ruled that the company was not entitled to tax breaks, and the company had to take an immediate hit of Rs 4,000 crore on their P&L account. 

That seems to be what Tata Power is apprehensive about. While the company highlights that according to the legal opinion received by the company it has a very good chance of winning, it says it was choosing to not recognise the amount as revenue considering it is still disputed. One of Tata Power’s officials says that there is always the chance that the Supreme Court might choose to look at the contract behind the dispute, and decree that if the company had promised power at a certain rate, then it was obliged to deliver power at that rate, no matter things that were not under it’s control.

Tata Power hence has taken the ultra conservative approach, delaying the recognition of revenue till it becomes indisputably certain, while Adani has chosen to be ultra-aggressive, taking on the risk that they may have to eventually reverse the amount. To be sure, neither of the two companies are breaking any rule. Both companies have explained their rationales for the treatments. But the thousands of crores of rupees that has been over-stated or understated, depending on your point of view, shows just how easy it can be to hoodwink an investor who looks only at a few numbers, like revenues and profits after tax, with your choice of accounting.

(This story was published in BW | Businessworld Issue Dated 08-09-2014)