All That Glitters ... Revisited

The first point is about the lower provision for depreciation. Reliance points out that depreciation was lower mainly due to two reasons. One, using the SLM method, only a maximum of 95 per cent of the cost of an asset can be written off. Since the limit of 95 per cent had already been reached in the case of some plants last year, no depreciation was provided for them in the current years first half. Morever, some assets purchased during the last year were eligible for 100 per cent depreciation and, therefore, were completely written off last year itself.

The second reason for lower depreciation is that they say, PSF plant had only begun trial production in the first half, and not commercial production. Therefore, the company was not liable to provide for its depreciation in the first half results. This, they point out, is within the letter of the law.

 

We agree. However, The Smart Investor team sought one clarification at this stage. Since they were including trial production in the sales and profit figures of the first halfs report, shouldnt Reliance have also provided for depreciation in the first half itself? Also, as we had pointed out in the article, the ICAI guidelines recommend that the prudent accounting practice is not to include trial production figures as sales in the results.

Reliances answer to this point is interesting. As they point out, the ICAI guidelines only recommended and do not make it mandatory for companies not to include trial production figures in the results. Moreover, the ICAI guidelines suggest that if trial production figures are included, then the company has to make a mention of it in the notes regarding accounting policies. And Reliance is doing this.

The Smart Investor agrees that what Reliance is doing is within the letter of the law. It is another matter, however, whether including trial production as part of results while deferring depreciation to the second half on a technicality is ethical or not. While The Smart Investor can argue about the ethicality of what Reliance did, it certainly cannot argue that what the company did was illegal.

The other clarification Reliance makes is about inter-divisional sales. We had pointed out in the article that inter-divisional sales are profit neutral, but not margin neutral. Thus a company could artificially inflate the margins of one division by lowering the sales costs/purchase costs of another division. Reliance says that all its interdivisional sales are strictly at prevailing market prices. And, therefore, the question of margins being affected does not arise since all divisions could have bought their raw materials from the market at exactly the same prices.

Another point Reliance makes is that with fresh capacities being commissioned by the company in almost all its divisions, it is internationally competitive because of economies of scale. And even though import duties on polymers have been lowered, and prices of certain products have crashed, Reliance can sell its products at those prices and still make profits. And since Reliance expects polymer and polyester prices to stabilise at the current levels, its expanded volumes, which are coming into play in the second half of the year, will give it bumper profits again.

The final point Reliance makes is that they are going to make provisions for taxes under MAT only in the second half and they have already announced this earlier. And this too is strictly within the letter of the law.

Given these clarifications, The Smart Investor would like to make some amendments to its original analysis. We had written that with fresh capacities being commissioned by Reliance, the company was expected to post excellent results in the second half and margins in almost all divisions was slated to increase because of better economies of scale. However, after its clarifications we realise that Reliance will probably have to make a higher depreciation charge because of the PSF and PP plant in the second half than we had originally estimated. And as we had pointed out in the article, Reliance will also have to pay MAT in the second half. Consequently, its net profits will be lower by that amount and its net profit margins may also be lower than in the first half.

The Smart Investor team had one additional query