Novelis to restate financials, Hindalco’s results may get affected too

Restatement of accounts is quite uncommon in India. Even if Indian companies discover bloopers they are either rectified prospectively in the P&L or retrospective effect is given through the balance sheet. The first practice will reflect in future financial statements and the second will not reflect in the profit and loss account, thereby not affecting the profit for the year. US GAAP in contrast requires companies to restate their financial statements.

Novelis was acquired by Hindalco in May 2007 and its financials were consolidated with that of Hindalco in FY’08. Now, Novelis has identified some errors in its accounts for the year ended March 31, 2008. The net effect of these errors was to inflate its consolidated net income by $45mn or approximately Rs 190 crore. The company will now have to restate its financial statements for the year.

Hindalco’s FY08 results mention that Novelis earned a net profit of $28mn under US GAAP, during May 16’07 to Mar 31’08 compared to a loss of $265mn in FY’07. It also said that during the post-acquisition period, the results benefited from certain income and expense items, totaling $21mn on a pre-tax basis. These were concerning fair value adjustments on the date of acquisition.

So, what exactly happened? It transpires that Novelis has a 50% German subsidiary Alunorf that runs a rolling facility. After being acquired by Hindalco, Novelis did a valuation study, and compared to the cost of $100mn on the books, valued its investment in Alunorf at $875mn. Further “based on this increased valuation, we recorded a step up in asset basis for this investment and established a deferred tax liability based on the statutory rate in Germany as of the closing date of the Hindalco acquisition…” Sorry for all that jargon, but am going to interpret this, and you can check if I have erred. Novelis revalued its investment in its subsidiary upwards and when it prepared its accounts, this difference would have reflected as goodwill on consolidation. GoC reflects the premium paid to acquire an asset, and some countries require it to be amortised just like depreciation in the books of accounts. Then, it reported a deferred tax liability in this regard, which gave it a tax benefit. It says that it overstated the tax benefit it got due to a subsequent (to the deferred tax liability being recorded) reduction in the German statutory tax rate. The company has said that the final restatement of profits will be known once it completes the exercise.

But as facts stand, it seems that Novelis may report a net loss and not a profit. The impact on Hindalco’s net profit of Rs 2,387 crore could be about 8%, though this could vary as Novelis follows US Gaap whereas Hindalco follows Indian accounting standards. The final effect will be known only later. But this is an embarrassment that it would have least expected and wanted. This is the period when most companies hold their AGMs and Hindalco will want this issue resolved by then, so that it does not have to face up to uncomfortable questions from shareholders

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