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6 ways companies reported earnings differently this season
As a stock market investor, you come across so many numbers, especially while analysing companies. It can get pretty confusing.
Yet, there are guiding principles that underlie these numbers—accounting rules that ensure every company reports numbers in the same way. Without these, there would be utter chaos!
Recently, large Indian companies had to shift to a new accounting model – the Indian Accounting Standard (Ind-AS). Earlier they followed the Indian Generally Accepted Accounting Principles (IGAAP).
This shift could throw a wrench in your company analysis. You would need to adjust past earnings. Otherwise, you would be comparing apples with oranges. For this, though, you need to first understand the changes.
Here are six key modifications:
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Substance over form:
The new principles aim to ensure company financials are as realistic as possible. The key issue with reporting happens because companies often make or receive payments over a period of time. The payment is not always immediately after delivery, which is what you do when you buy from a retail store. So what payments should be recognised, what should not? These are stated by accounting principles. This ensures companies report in a uniform manner.
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Revenues, margins change:
The biggest change due to the new principles will be in how companies measure and report revenues. This, in turn, affects most financial measures like profit margins, book value, etc. This is because companies will now have to take into account excise duties too while calculating revenues. Earlier, they used to deduct it from the revenue. This means revenues are likely to appear larger. This, thus, will make margins look narrower.
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Expenses and investments:
It’s not just income. Ind-AS also changes how expenses are calculated. Companies can spread out their expenses over a period of time. This is called ‘capitalisation’. The older standard – IGAAP – did not allow this for major repair-related expenses. Under Ind-AS, companies can now capitalise such expenses. The immediate effect of such a capitalisation is that expenses are lower making profits look larger. Over a period of time, however, the expenses increase, thus lowering profits and Earnings Per Share (EPS).
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Fair value over book value:
You can value assets in two ways – using the cost price (book value) or the current market price (fair value). Ind-AS prefers fair value over book value. So investments, assets, liabilities, and even the stocks held by employees as compensation would be based on fair value. This could change company balance sheets. In the income statement too, it could change ‘employee costs’ because of the stock valuation. This, in turn, affects profits and margins.
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Dividend recognition:
Suppose, dividends for the previous ‘calendar’ year are distributed in the next ‘financial’ year. Should they be considered in the financial statements for the previous year or the year in which they were distributed? Ind-AS states that the dividend will be considered for the year in which the shareholders approve of it. So look for the board’s general meetings when dividends are approved. That’s the year of recognition for dividends. This could affect a company’s book value and Return on Equity (RoE).
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Transfer pricing:
You may have heard about the Vodafone row. It deals with ‘transfer pricing’. The new accounting standard affects this. Group companies have subsidiaries. The parent company and the subsidiary company may exchange assets or services. When it comes to accounting, this is considered as ‘buy’ or ‘selling’. Ind-AS states that this sale or purchase should be considered at fair value—the current market price. After all, it is what would happen if the company were to buy from or sell to any other independent entity. This is one of the biggest changes in the accounting standards. Because of this, companies’ tax liabilities may also differ over the next few years.
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Rs 4.65 lakh crore
The 30 companies that form the Sensex together reported a net profit of Rs 4,65,156 million in the quarter to June 2016. This is as per the new norms. Kotak Institutional Equities expected the figure to be a little lower at Rs 4.5 lakh crore. This means the Sensex companies beat Kotak analyst expectations.
