Instinctive Inhibition in Informing the Investors of Impairment!
Satyam Computers is still referred to in all discussions on corporate scandals because it created false receipts of bank deposits. Showing assets at an inflated value in the balance sheet is as sinful as showing fictitious ones.
 
Companies, with the help of cooperative auditors, seek to postpone for as long as possible the recognition of impairment in the value of the assets.
 
Assessing impairment is often a matter of judgement and opinion, as the board and the auditors take shelter under expedient valuation methods and buoyant projections and forecasts.
 
A well-governed company can set itself apart by sharing adequate and advance information to the investors on the state of its investments and assets, and be transparent in the event of an anticipated fall in value and be proactive in making the provision to match the expected economic value of the asset.
 
A case that is analysed here is of a company in the auto components space.
 
This company recognised an impairment of Rs121.56 crore in the second quarter (Q2) of FY23-24 results, in addition to a provision made in Q1FY23-24 of Rs18.75 crore. It had a cumulative impairment provision of Rs329 crore as of 31 March 2023, against a gross value of investment of Rs365 crore.
 
In this case, the company invested in an intermediate holding company in the Netherlands in the form of non-convertible, redeemable preference shares. The Dutch company invested, in turn, in an operating company in the US.
 
The investments into the US company happened progressively from 2019 till the current year, and simultaneously a provision for impairment was being made in each of the years recognising a potential erosion in the carrying value of the investment.
 
It may be unfair to fault in hindsight, without the benefit of full facts, the action of the company in continuing to invest in a business that was losing value progressively.  
 
The board was continuously evaluating the fair value and making provisions which it considered appropriate to address the erosion.
 
The US company was sold during Q2FY23-24 and the final impairment/ loss was recognised in the said accounts.
 
The interesting point to note is that the cumulative loss of Rs140 crore recognised in Q1FY23-24 and Q2 appears to be additional investments or funding made during this very half-year!
 
The reason to come to this inference is that the investment value of Rs365 crore had a corresponding impairment provision of Rs329 crore as of 31 March 2023. The write-off of Rs140 crore in this half-year can only be of additional funds infused into the subsidiary company.
 
Another data point is the increase in the borrowings of almost a like amount without any corresponding increase in the current or the fixed assets during this period, buttressing the fact that it represents a loss or a write-off in the accounts towards the US venture.
 
However, the notes to the Q2FY23-24 results do not explicitly state the additional amount invested which was written off parallelly!
 
The company took the approval of the shareholders for the sale of the indirect subsidiary by a postal ballot for which the process was initiated on 17 May 2023.
 
However, the board held a meeting on 5 May 2023 to approve the accounts for the year ending (YE) 31 March 2023, which did not bring out any possibility of an immediate sale or the need to make further investments in the loss-making subsidiary.
 
Even the annual report, which the board approved on 5th May, specifically mentioned that further investments would not be considered in the loss-making subsidiary. A portion of the board’s discussion (MDA) is extracted for reference- “The management has been focusing in the last couple of years on business development and operational improvements. The former initiative has had reasonable success. The latter has helped improvement in Q, C and D metrics. However, the recovery post-COVID in the US market has not happened. While the semiconductor shortage has somewhat eased, the US auto industry has entered into a phase of slowdown. This has resulted in poor offtake in the new business developed and even existing products. The turnaround planned has had a major setback. The Board is closely monitoring the situation and decided to restrict future investments and also review the best decision regarding the future of this business in the long-term interests of the Company.”
 
Clearly, the information shared in the board’s report appears to fall short of the information that must have been known to the management of an impending sale for which the process was initiated within less than a fortnight by convening another board meeting.
 
Also, the likelihood of further losses, based on additional funds that needed to be infused to get the monkey off the back, couldn’t have been completely unanticipated as the entire show folded up in less than six months.
 
Since the additional cash infused of approximately Rs140 crore stands written off within the same year, it is unlikely to figure in the annual accounts of March 2024 in a manner that a lay reader may be able to decipher.
 
The only place where this would figure is the related party schedule disclosing funds transferred as a loan or an investment. The auditors may also not draw any reference to this as the transaction stands completed in all respects and the loss has been fully accounted for.
 
While, as stated in the opening part, the company kept making some provision for impairment over time, the question is whether the full picture as known to the management was duly shared with the auditors, investors and ultimately, the market.
 
It would appear that the level of disclosure in the board’s report dated 5 May 2023 fell short of what the company was privy to and should have been made public in the interest of transparency.
 
The fond hope is that the board members feel contrite for the past lapse and explain in detail the entire write-off episode and the business rationale for the pumping in of extra cash just before the sale, assuming such to be the case!
 
Based on a legal opinion, the company has also recognised a deferred tax benefit of Rs113.34 crore, reflecting a potential tax loss admissible of about Rs450 crore, assuming an effective tax rate of 25.17%.
 
While it is a huge wager to assume a tax allowance for an investment write-off (caused by a capital reduction of the Dutch company) and hoping to get it allowed against the operating income in future periods, the company should also pray that no GST (goods and services tax) notice comes seeking a 18% tax on the Rs450 crore write off on some contrived logic, which has been happening, rampantly, of late!
 
Note: Any resemblance in the case and the facts to any corporate is purely accidental and not intended!
 
(Ranganathan V is a CA and CS. He has over 43 years of experience in the corporate sector and in consultancy. For 17 years, he worked as Director and Partner in Ernst & Young LLP and three years as senior advisor post-retirement handling the task of building the Chennai and Hyderabad practice of E&Y in tax and regulatory space. Currently, he serves as an independent director on the board of four companies)
Comments
alok.ambrosia
4 months ago
It would be very interesting to find out which company this is about ...
In fact its the responsibility of the esteemed writer to expose and identify such crooks !
yerramr
4 months ago
Very good illustration for improvement in corporate governance and audits.
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