Directly writing off expenses against reserves is a practice that many companies follow. The author feels that the growing tendency of direct write-offs may provoke companies to incur unwanted expenses at the cost of investor wealth.
The trend of directly writing
off expenses against
reserves is fast gaining
momentum and this could be
dangerous. After all, every outgo
must get reflected in the profit and
loss account, either in the form of
revenue expenditure or in the form
of amortization/depreciation.
With such direct write-offs being
permissible, companies can, with
impunity, incur unwarranted
expenses such as large marketing
and sales promotion expenses,
R&D expenses and so on. By
habit, investors are guided by
earnings per share and give little or
no importance to net worth per
share. Also, very little weightage is
given to payout ratio of profits (in
the form of dividends), believing
that the company is accumulating
reserves for expanding business,
putting into investments and so on.
If net worth per share is to be
ignored, then it is important, from
the shareholder’s point of view, to
look at the payout ratio. A low
payout of profits accompanied by
direct write-offs from reserves is
like pouring water through a sieve
and believing that you are storing
water for a parched day!
In the accounts of 2001-02,
well-known companies such as
TELCO, Bombay Dyeing and
Mahindra & Mahindra have written
off large amounts of
miscellaneous expenditure and
other forms of deferred
expenditure directly through share
premium account and other
reserves. Consequently, annual
write-offs in the profit and loss
accounts have been eliminated and
the profits of subsequent years have shown a dramatic increase,
albeit as the result of mere
accounting changes and not as a
result of—
1. Increase in production
2. Increase in selling prices
3. Improvement in production
efficiencies or
4. Decline in input prices.
The effect of accounting
adjustments is reflected in the
future profitability of the
companies, when profits show a
more than proportionate
improvement as compared to
increase in turnover. The exact
impact, however, cannot be
calculated because of lack of
details regarding the original
write-off schedule over the years.
TELCO was making annual
provisions of Rs. 200 cr for
“miscellaneous expenses” before
the direct write-off. In the case of
Mahindra & Mahindra, the impact
will not be noticeable on a YoY
basis because, most write-offs by
Mahindra & Mahindra were related
to expenditure capitalised afresh
during 2001-02.
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