Thanks to the wide media coverage, today, the economic issues concerning the nation are discussed with such great interest, which was, perhaps never seen before. The CAG's views and his loss calculations on a series of issues like 2G, coal blocks etc. generated lot of heat. Recently, the ex- Chief Justice of India, reportedly made a comment that 'the loss is a fact and the profit, a matter of opinion'. The subsequent days witnessed lot of discussions around this statement. Let us look at it from a corporate finance perspective. The reported profit or loss of a company is not sacrosanct, as it is reported by the company itself! One may argue that the accounts are audited by independent auditors; and hence, could be construed to be presenting a 'true and fair' picture of the state of affairs. But the towering examples of Lehman Brothers and Satyam go against this argument.
There are many ways in which a company can manipulate its accounts to exhibit a totally different picture as against the reality. On one side, we have firms which presented rosy profit figures before raising funds from the public; and on the other side, there are firms which kept making losses (intentionally) to attract certain benefits. Few years ago, the government was forced to introduce Minimum Alternate Tax (MAT) to tax those companies, who had intelligently found ways of avoiding tax by exploiting the loopholes in the tax laws. A recent issue of ET Wealth (24 Sept 2012) sums up various ways in which a firm dresses up its accounts, like not reporting certain expenses, capitalisation of revenue expenses, tampering with depreciation, over/under invoicing of revenues etc. Swaminathan Anklesaria Aiyer says 'I know of no principle in economics or audit that says losses are real, but profits are not' ('Profits and Losses Are Not Facts, The Economic Times, 26, September, 2012).
Profits and losses are historical numbers, so let us look at the principles of Valuation. Value of any asset is defined as the present value of the future benefits expected to be derived from the asset. There are two important components that go into the valuation exercise - the expected future cash flows representing the future benefits and the required rate of return used to compute the discounted value (present value). The first component, cash flows, as the name suggests are 'expected'; hence are subjective and a matter of opinion. Same is the case with the discount rate, which is again, based on the expected rate of returns, and hence subjective. So, any exercise of valuation is also subjective and not a matter of 'fact'. As Aiyer says, the only matter of fact is the price that one pays to acquire the asset! Market price is a fact, as this represents the actual payment made by the buyer to the seller. But ironically, the market price keeps fluctuating almost on a real time basis!
I would like to go with Prof. V Raghunathan, who says '...CAG has not only shown his innocence of the principles of financial engineering involved, but also confused the entire issue, so that it is difficult for an average person to appreciate where the CAG may be right and where he may be wrong.' (Intent versus Fact, The Economic Times, 21 September 2012).
There are many ways in which a company can manipulate its accounts to exhibit a totally different picture as against the reality. On one side, we have firms which presented rosy profit figures before raising funds from the public; and on the other side, there are firms which kept making losses (intentionally) to attract certain benefits. Few years ago, the government was forced to introduce Minimum Alternate Tax (MAT) to tax those companies, who had intelligently found ways of avoiding tax by exploiting the loopholes in the tax laws. A recent issue of ET Wealth (24 Sept 2012) sums up various ways in which a firm dresses up its accounts, like not reporting certain expenses, capitalisation of revenue expenses, tampering with depreciation, over/under invoicing of revenues etc. Swaminathan Anklesaria Aiyer says 'I know of no principle in economics or audit that says losses are real, but profits are not' ('Profits and Losses Are Not Facts, The Economic Times, 26, September, 2012).
Profits and losses are historical numbers, so let us look at the principles of Valuation. Value of any asset is defined as the present value of the future benefits expected to be derived from the asset. There are two important components that go into the valuation exercise - the expected future cash flows representing the future benefits and the required rate of return used to compute the discounted value (present value). The first component, cash flows, as the name suggests are 'expected'; hence are subjective and a matter of opinion. Same is the case with the discount rate, which is again, based on the expected rate of returns, and hence subjective. So, any exercise of valuation is also subjective and not a matter of 'fact'. As Aiyer says, the only matter of fact is the price that one pays to acquire the asset! Market price is a fact, as this represents the actual payment made by the buyer to the seller. But ironically, the market price keeps fluctuating almost on a real time basis!
I would like to go with Prof. V Raghunathan, who says '...CAG has not only shown his innocence of the principles of financial engineering involved, but also confused the entire issue, so that it is difficult for an average person to appreciate where the CAG may be right and where he may be wrong.' (Intent versus Fact, The Economic Times, 21 September 2012).
No comments:
Post a Comment