Financial Accounting Blog

Tuesday, November 04, 2003

This Business Standard article is from an Indian publication and provides some good examples of how companies can use management estimates in their Balance Sheet numbers to make their financial position look better than it actually is...

GDS' analysis points out that accounting for ESOPs, deferred tax liabilities, valuation of goodwill, valuation of impaired assets and the treatment of contingent liabilities, while being perfectly legal and according to the accounting standards, may be more of a statement of opinion than of fact.

Changes in the accounting treatment of these issues could result in profits being very different from the published figures,
in spite of the fact that there's no difference in the amount of cash flowing in or out of a company. "

GDSIL's report also points to several other areas where their interpretation of accounts is different from the published figures, after taking into consideration adjustments for diminution in value of investments, capitalisation of interest and other intangible expenses, exposure to subsidiaries and many other issues.

They have then re-calculated profits after making these adjustments, and have found that there was a difference of 15 per cent or more in the profits of 70 companies.

The key takeaway from the GDSIL study is that there's no alternative to go deep behind the published net profit figures if the investor wants to make an informed decision.

Alternatively, he could discard profit and concentrate on cash generated. As they say, "Cash is fact. Everything else is an opinion."