Well, far from any effort to explain to the aforesaid common man how this is possible, our pink papers, last fortnight, added to his wonderment. In a painstaking study, one of the papers announced that over 2200 companies’ aggregate sales fell by 1.3 per cent in 2001-2002 but their net profit rose 1.8 per cent. In percentage terms, this might not mean much to the layman but when considered in absolute terms of sales of over
Rs. 700,000 crore and net profits of over Rs. 30, 000 crore, the full impact hits him.

Of course, the paper has explained how this was possible. Mainly, it says, it was due to severe cost cutting measures adopted by India Inc. On the income side, ‘other’ income grew 13 per cent to Rs. 28,358 crore during the year, which also helped. The cost cutting included reduction in staff through payment of VRS and lower interest payments. While this would satisfy most people who don’t know a debit from a credit, with a little thought even they can see that some questions arise.

They may well ask, why should a company wish to show a higher profit when it, as a corollary, has to pay more tax on it. The answer here is that most of them do not pay taxes at all, so versed are they on how to take advantage of the numerous loopholes in corporate and tax laws. Secondly, a higher profit means a higher price of the company’s share in the stock market which gives it more credibility with the investing public and more collateral for institutional and other loans. It also increases the valuation of the company and of the investors who hold its shares. This is something of a joke. Imagine you bought a company share for Rs. 100. Six months later it is quoted at Rs. 150. There is an immediate increase of 50 per cent in your net worth. Unfortunately, it does not translate into cash unless you sell the share that very day. Otherwise, the share price could fall to Rs. 50 in another six months, lowering your net worth. Hence, without any further investment or withdrawal your worth goes up or down! This is real Alice in Wonderland stuff but, believe me, it works.

Now let's look at one of the reasons given for a company selling less and earning more. It’s called ‘other’ income. Simply, what this means is if your salary is Rs. 1,000 a month and in some month you sell your accumulated old newspapers for Rs. 300, your income in that month is Rs. 1,300. Your income has definitely gone up in that month but your income is the same. Companies do the same but on a much larger and creative manner. We’ll come to that in a minute.

All right, let’s accept that our captains of industry are all geniuses. Another question relates to why was it necessary to cut costs only now. Is it possible that in previous years the sales were so high that the revenue covered the flab and still left a profit? Could there be any other explanation? Certainly, it cannot be argued that the flab was accumulated in just the year under review, it must have built up over many years. In that case, the companies must have been making obscenely high profits in that they could afford to keep their market capitalisation at a lower level. And, if they were making more profits and deliberately making unnecessary expenses, it may say a lot about their business acumen but very little about their integrity vis-à-vis their shareholders. The bubble of India Inc.’s creative accounting practices has been burst by a study conducted by Global Data Services, a subsidiary of the rating agency, Crisil.

It says that of 639 firms studied, 139 overstated their income while 87 understated it during 2000-01. And how did they do it? Here are some instances from the study: One company spent Rs. 50 crore on raising capital and on other items which was withdrawn from the general reserve fund. And since this fund is not required to be shown on the profit and loss account, the operating profit went up by that amount. Now here is a case of deliberately hiding expenses but what does the company say? "(We have) not violated any law. Our accounting practices are as per international standards."

Another company used the accounting trick of capitalising expenditure which makes it possible to withhold the item from the P&L account or only record part of the expenses incurred. This company played this trick in respect of Rs. 57 crore worth of interest payments.

Yet another case was sheer effrontery. A company claimed income tax refund of over Rs. 50 crore. It was disallowed prior to the accounting year 2000-01 but the company showed it as a credit in the P&L for that year. There are many more. One thrust its fall in investment on the contingency reserve fund. Another (and this is funny) showed taxes payable in previous years as income in the year of accounting. Reason: it did not have to pay it in the year under review!

The companies involved in these cases of creative accounting are not fly-by-nights. They include such stalwarts as Videocon, Spic, Zee Telefilms, Nocil, Hindustan Motors and Bombay dyeing among others.

They will, of course, all claim that they have not done anything that is illegal; or is in violation of the tax and other laws of the country relating to corporates. Let’s accept that. But what about the investors, especially the retail investors? Are these companies not giving them an incorrect picture of their financial position? Are they not ramping the market value of their shares to give their shareholders a false sense of security and inveigling others into trading their shares, thus increasing their market capitalisation?

Institutional investors understand these ‘legal’ accounting tricks and go along with them as their own worth is based on the market cap, and the higher the market cap the higher is their paper worth. But what about the retail investor who invests his savings for a return? He cannot live on the appreciation of the value of his investment in the market. He wants returns in terms of ‘real’ money—cold hard cash—with which he can educate his children and live a reasonably decent life. Looking at the companies named in the Global Data survey, it would appear that such accounting magic is more common among the giant mega corporations than in small businesses. Probably because of the clout the large companies have.