KARACHI, Feb 3: The six months accounts of Nishat Mills Limited released on Monday brought into sharp focus the need to settle a monumental issue: How should companies treat the impairment in value of ‘Investments Available for Sale’?

Nishat Mills reported profit after tax at Rs1.2 billion for half year ended Dec 31, 2008. But the company auditors ‘qualified’ the accounts with the observation that the decline in fair value of ‘available for sale investments’ in quoted companies had been recognised by the company directly in equity, instead of impairment loss through profit and loss account (P&L) as required by International Accounting Standard (IAS) 39: “Financial Instruments: Recognition and Measurement.”

Management defended its treatment of the amount by explaining at some length of how and why it thought the “impairment loss was not significant and prolonged.”

Auditors, nonetheless, calculated that if the impairment loss had been recognised through P&L account, profit for the half year amounting to Rs1.2 billion would have converted into loss of Rs1.9 billion.

The Nishat Mills’ case would not be one in isolation. Stock market turmoil of 2008, which saw a 66 per cent plunge in equity values from its peak prices and 31 per cent drop in 4QCY08 could have pushed countless companies and banks with heavy portfolio into similar arguments with the auditors.

Says Mohammad Sohail at JS Global: “Whether the impairment of value is temporary or permanent and should it be routed through Equity or P&L will remain a major risk to the reported profits of key companies.”

He recommended that the Regulators should clarify the matter. Left to themselves, the companies would post a profit/loss which might be at a wide variance with the figures that auditors have in mind, just like the case of Nishat Mills.

Knowledgeable people at the market admitted that such an ambiguity had vast potential of creating confusion in the mind of investors. Who to believe? A profit construed by one (company) could be a loss to the other (auditors), or vice-versa.

Such inconsistency in reporting would ‘materially’ impact the price of a company’s stock and could provide unfair advantage to a few at the cost of other investors.

IAS 39 deals with recognition of financial assets and liabilities, including investments.

“The standard requires companies to classify investments in three major categories, namely, Held for trading (HFT); Available for Sale (AFS) and Held to Maturity (HTM) with specific accounting treatment for each classification,” explains Sohail. HFT Investments were carried at fair value with gain or loss through P&L, while HTM investments were carried at cost generally pertained to investments which the entity intended to hold until maturity, like Bonds, T-Bills etc. AFS, the major investment category for listed equities at the KSE, required companies to measure investments at fair value with any increase or decrease in fair value recognized in equity as surplus or deficit.

IAS 36: “Impairment of Assets,” on the other hand provided that if there existed conditions which indicated a potential for impairment in an asset or class of assets, the carrying value of the asset/class of assets should be compared with its recoverable amount (fair value).

If the carrying amount exceeds the recoverable amount an impairment loss for the difference should be accounted for in the P&L.

The implications of the two IAS 36 and 39 were routed in the fact that the stock market crash would overshadow the profits of companies, with major investment portfolio, when the carrying amount of investments, which would exceed the fair value (recoverable amount) would result in impairment loss in P&L.

Significant and prolonged slump in fair values of investments that resulted in impairment might have to be recognised in P&L account rather than in equity through adjustment in revaluation surplus.

Khurram Schehzad at Invest Cap stated that the reaction of auditors in case of Nishat Mills suggested that other blue chip companies holding large equity portfolios, such as D G Khan Cement; Packages; Dawood Hercules; Habib Bank; MCB; ABL; NBP and BAFL could face similar complications as their portfolio stock prices had also dipped down by 31 per cent since removal of the ‘floor’ on Dec 15.

Khurram observed that as far as banking sector was concerned, the SBP and the PBA were in some sort of discussions for applying the standard as and when appropriate or any waiver to be given to banks. However, SBP through its recent circular had maintained its stance in terms of revaluation losses as per normal practice.

“Therefore, the recent downfall of the market, with the standard being applied, would dent the banking sector’s equity in the form of higher revaluation losses on their investment portfolios,” Khurram at InvestCap stated, adding: “Banks with higher exposure in the equity market, such as HBL; MCB; ABL; BAFL and UBL, would book higher unrealized losses in this manner.”

Many at the market thought that the Securities and Exchange Commission of Pakistan (SECP) could have to step in to mediate between companies and the auditor.

Nothing would be more harmful and misleading for investors than an inconsistent treatment to the impairment in value of securities, by different companies.

On Jan 30, the SECP had issued a clarification for companies, stating that for the purpose of preparing the financial statements for the period ended Dec 31, 2008, they might use market price as quoted on the stock exchanges on Dec 31, as fair value of securities.

The apex regulator noted that the resultant revaluation surplus/deficit would be treated in accordance with the IAS 39, which provided that the existence of published price quotations in an active market was the best evidence of fair value and, when they were available, they must be used to measure fair value.

“Such prices represent actual and regularly occurring market transactions on an arm’s length basis,” stated the SECP and concluded on the note: “Due to the significant decline in the market and off market price being still lower, the listed companies were facing difficulty in establishing the fair value of the quoted securities for the purpose of preparing the financial statements for the period ended Dec 31 and they had therefore approached the Commission for clarification in the matter.”

That scarcely answers the pivotal question whether the impairment of loss on securities available for sale, should be taken directly to the balance sheet or routed through the profit and loss account.

SECP would have to take upon itself the responsibility of finding a quick solution that is not only acceptable to both, the companies and their auditors, but is also in compliance with the related International Accounting Standards.