Accounting games may wreak havoc in January

As the Gulf economies sit down to take a stock of how have they tackled the impact of the global financial crisis, they find themselves basked under the stares of a suspecting media.
Though companies in the region have gradually come to accept the importance of maintaining transparency and gaining trust in the markets; large-scale lacunas remain. With ‘green-shoots’ of growth already out from the developed world, the Middle-East and more so the Gulf countries are yet ascertain as to how deep and muddy waters has the financial crisis thrown them into.
Come January 2010, some new set of skeletons may tumble out. Though the region is expected to record an all-round recovery along with the world, and rising oil prices are expected to provide it a strong support; large and cocky real estate companies in the region may relegate to a deeper suffering.
The buzz in the market is that large real estate companies have tried to use all possible loopholes in accounting principles to their advantage. While the figures suggesting the decay of companies like Lehman Brothers that triggered the crisis were at least correct in the West, here even the statistics remain blurred. The end result: a second wave of financial disarray may let loose in the region the next year exactly when the onset of a global recovery is predicted.
Up for debate are the balance sheets of several companies that declared their results in January 2009. The GCC countries do not have set accounting standards and follow a mix of accounting principles from all over the world. Audits made mandatory by the regulators overseeing listed companies in financial markets allegedly turn a blind eye to the high level financial games that several of these companies with 'bright' finance professionals play.
“The problem is that this kind of gain is really not sustainable. Property gains don’t go on forever (they have already declined substantially at places like Dubai), and the developers may soon feel the pain of a price fall as all revaluation losses also have to be booked in the income statement,” says Binod Shankar a Dubai based Chartered Financial Analyst (CFA).
What’s interesting is that such accounting tactics may force an additional expenditure for these companies. “There is always the danger that shareholders see the higher profits (mainly due to revaluation gains), think that all the profits are realised and hence ask for more dividend. None of the revaluation gain is in cash and the company may end up paying dividend out of capital,” Shankar adds.
Interestingly, none of this is illegal; the International Financial Reporting Standard (IFRS) explicitly allows this accounting treatment as per International Accounting Standard IAS 40. However, the problem is that none of the revaluation gain is realised.
Fair value i.e. the current market price of an asset that the IFRS insists is the authentic price to be recorded on balance sheets, income statements and cash flow statements. It is the price that a buyer is willing to pay to the seller under the prevalent market conditions. In the Middle East, fair value has become a joke. As explained above, even as the real estate prices have declined by as much as half their previous value at many of the places in the Arabian Gulf, companies have gone ahead and raised the prices of assets (on the account sheets) under their command by percentages that were prevalent during the time of the global economic boom. A good portion of the inventory has been shown as ‘available for sale’ -- an accounting loophole that allows companies to not record inventories and keep them off the balance sheets. A good amount of asset has also been securitized to escape scrutiny.
“There is another scary fact. A few companies went on to show those buildings that were still being built as a part of there assets the last year. This strengthened their balance sheet then. However, this year when those buildings have actually been completed they cannot show them as a part of their asset. It will be double whammy for them (the real estate companies) as many projects have been abandoned and no new assets are coming up this year,” a Dubai based analyst said.
The largest real estate companies, the ones who have particularly been noticed fiddling with their balance sheets cannot even be questioned in an open forum for the fact that they enjoy a tacit government backing.