Case study -- Bengal
Aluminium Company
Case Overview
Mohini Sharma - an investment analyst in Esbeeye Securities,
which is a medium-sized stock brokerage firm.
She specializes in the stock of non-ferrous metal companies and
provides reviews on these stocks in the firms newsletter. The
newsletter is a monthly publication and is sent to Esbeeyes clients
who are mostly private, non-institutional shareholders.
While preparing an analysis of Aluminium companies Based on
their annual reports for the year ended March 31, 2008. She came
across the following footnote appearing in the financial statements
of Bengal Aluminium Company:
During the year the company has changed the method of
depreciation for the main smelter from the written-down-value
method to straight line method. If the company had not made this
change, the depreciation expenses for the current year would
have been higher by Rupees 141,586,327
Cont.
No other reference to the depreciation method change was
available in the companies report, except an item in the
statement of profit and loss, Excess provision for depreciation
written back, Rupees 782,312,370., shown above the line. Until
last year, Aluminium companies have followed similar accounting
policies. The main smelter of Bengal Aluminium was brought on
April 1, 2005, for Rupees 3000 million with an estimated useful life
of 10 years and was expected to fetch rupees 150 million at the
end of that time.
Cont.
There are 5 major producers in the Aluminium
Industry and they vary widely in terms of sales and
total assets. On these dimensions, National
Aluminium Company comes closest to Bengal
Aluminium Company. Sales and profits after tax (in
million) of the two companies in recent years are as
follows:
Year
ended
March
31
Bengal Aluminium
National Aluminium
Sales
Sales
Profit after
Tax
Profit After
Tax
2005
12150
1290
11860
1090
2006
13240
1380
12520
1350
2007
15890
1630
14100
1890
2008
20660
2570
17450
2640
Mohinis immediate problem is how to evaluate Bengal
Aluminiums 2008 result in light of the companies past
performance , and the 2008 results of National Aluminium.
Her other concern is to find out the managers motives for the
depreciation policies switch.
1. What would have been Bengal
Aluminums profit after tax for the year
ended March 31, 2008 but for the change
in depreciation method?
Sol. Accounting for decrease in depreciation expenses:
Profit after tax
=2,570,000,000 -141,586,327
=2,428,413,673
Accounting for the effect of depreciation written back
method
Profit after tax
= 2,428,413,673 782,312,370
=1,646,101,301
2. Compute the ratio of profit after tax
to sales for the two companies for each
year.
Sol. Bengal Aluminium Company
2005
10.61%
2006
10.42%
2007
10.26%
2008
12.44% (Including change in
depreciation valuation)
11.75% (Without Including change in
depreciation valuation)
National Aluminium Company
2005
9.29%
2006
10.78%
2007
18.86%
2008
15.10%
3. What could have been the
motives for Bengal Aluminums
depreciation policy switch?
Sol.
Decrease in Depreciation Expense Should have been
923,898,697 instead of 782,312,370.
Increase in net profit value Firstly, it should have been
2,428,413,673 instead of 2,570,000,000
More importantly, in this case, 782,312,370 must have been
added back to the profit and loss account.
Therefore actual profits for 2008 would be 1,646,101,303
instead of 2,428,413,673.
4. Do you consider the
companies disclosure of the
accounting change adequate?
Sol. The companys disclosure of the accounting change is
adequate, provided that it can justify the reason for its change.
However, the money credited to the profit and loss account should
not be considered as inflow of cash. It is merely an accounting
change.
5. Draft a shot paragraph on the
accounting change which Mohini should
consider including in her report on
Aluminum Stocks.
Sol. Based on the percentages from Question2, it is clear that BAC
has been lagging behind NAC in terms of net margin, specially after it
installed the new smelter.
However, one would have to consider that those figures may not be
truly representative of the actual situation and could just be bloated
figures.
Based on our estimation the actual profit/sales percentage would be
closer to 7.9 than the calculated value.
Since it has been mentioned that the other aluminium firms practice
similar accounting practices, one could assume that the figures for
these other companies could also just be bloated figures.
Caution is advised in investing in such firms.
A clear understanding of these companies' account books would be
mandatory.
