BHEL’s orders crawl, accounting policy change boosts profits

Engineering company Bharat Heavy Electricals Ltd, or Bhel, saw its order book rise by a meagre Rs 4,000 crore to Rs 158,000 crore in the December 2010 quarter, compared to the previous quarter. Order book position is a key variable for any engineering company, as future revenue streams are forecasted, based on the order book’s level and growth. There appears to be a slowdown in new projects, which was visible when Larsen & Toubro declared its results too, recently.
Bhel’s performance, at first, appears very good. Its net sales rose by 25% to Rs 8,850 crore and other operating income rose by 35% to Rs 174 crore.

On the cost front, its raw material costs rose at a relatively slower pace, compared to sales, of 22%. While employee costs rose by barely 10%, other expenditure rose by a sharp 59%. Bhel’s other expenditure would include chiefly erection and engineering costs, incurred on its projects, and power, travel and freight costs.

Bhel’s major segments are power and industry. The power segment’s revenues rose by 28% and profit rose by 25%, and was the main contributor to performance. The industry segment lagged, with sales rising by 19% and profit by 12%.

Still, Bhel’s operating profit margin improved by 1.4 percentage points to about 23%. After accounting for a 40% increase in depreciation and a 21% decline in other income, its net profit rose by 31% to Rs 1,403 crore.

That would appear to be a good performance, but for one fact tucked away in the notes to its financial statements. Bhel has changed its method of accounting. This pertains to the percentage completion method used to account for revenues.
Percentage completion: Engineering companies use the percentage completion method for accounting revenues. They account for expenses when they are incurred, but they do not account for payments received from customers, till the project reaches a certain stage of completion. Thus, in most project-oriented operations, income is booked typically towards the end of the project. This is a conservative accounting method, recognising the risks associated with a long gestation project.

Bhel has said that its sales have gone up by Rs 444 crore during the December quarter, and profits by a similar proportion, due to an accounting policy change. It said that its method of calculating percentage completion has been changed, to remove the mismatch between creation of 2.5% contractual obligation and recognition of revenue, on trial operation. Bhel creates a 2.5% provision to take care of any warranty-related obligations, on trial operation. But it did not book this amount as revenue, but accounted for it later, after the contract was completed. The change means that it books revenue and creates the 2.5% provision at the same time.

If one adjusts revenues in December for this, its sales growth falls by about 5 percentage points. There would be some impact on profits too, said the company, but did not specify the quantum. Bhel’s stock closed at up 1.75% at Rs 2218, on Friday.

Read the Bhel press release on its results on this page and see its financial results table here.

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