Sri Lanka accounting watchdog reveals valuation tricks
July 27, 2011 (LBO) - A Sri Lankan accounting watchdog has revealed how companies inflate their profits and balance sheets using false revaluation techniques that in two cases led to initial public offer applications being rejected.
New accounting standards coming in January 2013 will provide more clarity on fair value and revaluation methods, said Ajith Ratnayake, director general of the Sri Lanka Accounting and Auditing Standards Monitoring Board which monitors company financial statements.
These are part of the International Financial Reporting Standards (IFRS) that set out a framework for measuring fair value and require disclosures about fair value measurements.
Two recent IPO applications sent to the SLAASMB for vetting by the Securities and Exchange Commission were not approved after they rejected revaluations by the companies, Ratnayake told the 36th LBR - LBO CEO Forum.
It was a panel discussion on 'Convergence of accounting standards in 2012: are CEOs ready?' organised by Vanguard Management Services in association with Sri Lanka Telecom at the Ceylon Continental Hotel on July 21.
Most of the new standards are going to come from January 2012 but SLAASMB is particularly concerned by IFRS 13 which relates to fair value measurements and comes into effect by January 01, 2013, Ratnayake said.
"That is a standard we as a regulator will watch for and ensure it is well complied with. This new standard, IFRS 13, will give you greater guidance and greater clarity as to how the fair value should be measured. That's something we will regulate a little more carefully in terms of fair value measurements."
Ratnayake gave two recent examples where the SLAASMB had to intervene to prevent problems in the future.
One case referred by the SEC was an IPO application where the company had re-valued property, plant and equipment at a substantial valuation.
"A property that had been bought in June 2010 - just a year ago - at the rate of 137 rupees a perch was re-valued in March this year at 100,000 rupees per perch - 137 rupees going up to 100,000 rupees a perch," Ratnayake said.
"Then in September 2010 they bought another property at 37,000 rupees per perch and then again in March 2011 - about six months later - it was valued at 300,000 rupees per perch.
"And in November 2010 they had bought another property for 56,000 rupees per perch and again re-valued in March 2011 - just six months after - at 100,000 rupees per perch. And these re-valuations had given rise to 900 million rupees revaluation surplus."
The 900 million rupees arising from the difference in revaluation were issued as bonus shares - assets coming in the balance sheet and increasing the net assets - to the owners.
"Now they apply for an IPO," Ratnayake said. "We looked at it and then we also consulted the chief valuer and we said this cannot be accepted. The SEC did not allow the IPO to proceed. So the IPO did not see the light of day."
In the second case, a company bought several items of property, plant and equipment and built up a complex with the cost of the work in progress valued at 484 million rupees.
"After the project was complete this was transferred to property, plant and equipment as a fixed asset," Ratnayake said.
"The 484 million rupee cost item was re-valued to 854 million rupees and a gain of 370 million rupees recorded in the books. This gain of 370 million rupees was used to issue bonus shares but not in proportion - the chairman was given a higher proportion than his shares in the equity of the company.
"This also came for an IPO. We looked at it and again we knew there was a problem. We also discussed with the chief valuer and we rejected that valuation. Therefore, the IPO did not see the light of day," Ratnayake said.
"If we had not looked at these things then you would have seen the extent to which people who apply for these IPOs would have got misled and would have thought the company had a certain different value and would have bought shares and they would have lost on those shares," he added.
"So fair valuation is an important area that has to be watched carefully," Ratnayake said.
The SLAASMB has also seen companies that have used models using false or inappropriate estimates and coming out with substantially big values which are not really true.
"So these are things for which there will be some guidance given in IFRS 13 but it does not solve the problem completely because there is still a judgement that is there," Ratnayake said.
"But there will be better guidance than that is available today in IFRS 13 and we will look to see whether that guidance has been appropriately applied by the companies when it comes to the future valuations."
Ratnayake also noted that some of the valuations rejected by regulators had been done by chartered valuers who were unable to justify their valuations.
"Mind you, these valuations that we have seen have been valued by chartered valuers and the valuations have been supported by them," he said.
"But the problem is the assumptions are not correct. There are issues related to the assumptions. Sometimes when a chartered valuer comes in front of us, we ask 'why did you make those assumptions', what is the basis on which they made the valuations, and they don't have an answer.
"Sometimes they just say 'my professional judgement'. That's all. What is the basis of the professional judgement, they cannot explain," Ratnayake said. "So these are some of the things one will have to watch for."
Fair valuation is something SLAASMB would look at closely to see if it has been done appropriately particularly if the company has substantial value on a particular asset and that asset has been fair valued.
"Then we will look into that company because that is something that can change the picture that is shown in the balance sheet and change the picture that is shown as profit in the financial statements. So these we will watch carefully."