Do not fall prey to creative accounting practices adopted by firms

There are many corporations who have resorted to inflating their numbers to attract investors. Ironically, the industry calls it “creative accounting”. It started off as a sporadic practice across different industry verticals, but now, it is more of a regular regimen for many companies. Luckily enough, equity analysts have been able to identify the spotty sheets and flag down instances of creative accounting. The following are some common instances where companies resort to furnishing cooked up figures.

Foreign Exchange profit and loss issues

Until recently, there was no way of knowing if a firm was serving fudged profit and loss figures pertaining to foreign exchange gains and losses. It goes without saying that in the foreign exchange landscape, the balance could either tip towards loss or profit, but companies have a tendency to fudge figures and always portray that they are making profits.

Until recently, there was no way to tell whether a company was making profits or losses using forex hedges. Forex is a tricky business and there could be national losses or gains, but with companies fudging profit and loss statements, it is difficult to  point out unrealized gains and losses on forex exposures. Despite some amendments in accounting practices, there are still fears that many listed companies are yet to divulge their losses.

Foreign Currency Convertible Bonds

Since many years, companies have been raising funds through foreign currency convertible bonds. It is inherent to these bonds that they have very low coupon rates and can be redeemed at huge premiums. Companies hope that the recovery premiums would never have to be borne by them because bond holders would opt for the conversion of bonds to shares.

However, conversion is often not sought in the stock market, because usually, the current market price (CMP) is usually higher than the conversion price. In such cases, the redemption premium paid is usually not reported in the profit and loss account, but charged to the share premium account.

It is a common practice now, but it is sad that companies do not report losses incurred on borrowed funds in the profit and loss statements across the life span of the bonds in question.

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