TechMahindra accounting continues to fox

Software company Tech Mahindra, part of the Mahindra group, is caught in a controversy over two accounting treatments, spread over three accounting years — 2007, 2008 and 2009.

Analysts tracking the stock were up in arms against the treatment, with some giving a ‘sell’ call on the stock. Analysis based on the information in the public domain raises a fundamental question — is the company hiding something?

Of the two treatments, one pertains to expenditure accounted for in the years ended March 31, 2007 and 2008 and the other to income accounted for and reported in the results for the quarter ended December 31, 2009.

In 2007 and 2008, the profit & loss account reported exceptional items of Rs 525 crore and Rs 440.1 crore, respectively.
These exceptional items were explained by way of notes 8 and 12, respectively, in the two years.

The note in the 2008 accounts reads: “During the year, the company has entered in to an agreement with a customer under which it will have exclusivity for 90 days in negotiating an engagement.

“As per the terms of the agreement, the company has made an ‘exclusivity’ payment of Rs 4,401 million to the customer, which is unconditional, irrevocable and non-refundable. Accordingly, this payment has been disclosed as an exceptional item in the profit and loss account. The project will be executed with a consortium partner who will bear part of the ‘exclusivity payment’.

“The payment from consortium partner will be accounted when it is contractually firmed up. During the previous year, the company had entered into a global sourcing agreement relating to the development of a global sourcing model for strategic outsourcing services with a customer for a term of five years.

“As per the terms of agreement, the company had made an upfront payment of Rs 5,250 million to the customer, which was unconditional, irrevocable and non-refundable.

“Accordingly, this payment had been disclosed as an exceptional item in the previous year profit and loss account.” It appears from the note that the treatment of classifying it as an exceptional item is based on the crucial words “unconditional, irrevocable and non-refundable”.

The issue is with respect to the classification as an exceptional item. Can a normal business related expenditure be classified as exceptional only because it is unconditional, irrevocable and non refundable?

The nature of payment itself is a bit ambiguous, going by a simple reading of the note appended to the accounts.  Why should the company pay such a huge sum of money only to have exclusivity in negotiation for a short period? If there is no certainty of a contract, what is the rationale for the payment? If there is a substantial likelihood of it, is it not a part of its regular business, and isn’t the amount akin to a marketing expenditure? If yes, why call it an exceptional item? How does the company hope to recover this payment if not from the value of the contract?

While expensing the payment in a single year in itself may not be disputed, its presentation certainly raises doubts.
Further as per the note, there is a recovery of part of the amount from a consortium partner. The note does not say the recovery is uncertain (by implication it is certain) but goes on to state that the share will be accounted when the contract is firmed up. Why? If the contact if not firmed up, how can it be said that a recovery is possible. If the broad terms are firmed up, then why not recognise it? Since there is no special mention of the same, are we to assume that even now the consortium partner is not finalised or the contract with them not firmed up?

A plain reading does make one very uncomfortable, resulting in a suspicion that the company is hiding something. Coming to the latest quarterly results, the note that has become a bone of contention between analysts and the company pertains to a restructuring by a customer of long term contracts with the company from April 1, 2009, involving changes in commercial (including rate reduction) and other agreed contract terms. As per the amended contracts, the customer has paid the company restructuring fees of Rs 968.19 crore.

“The services under the restructured contracts would continue to be rendered over the life of the contract. The restructuring fees received would be amortised and recognised as revenue over the term of the contract on a straight line basis.

The amount of Rs 15,036 lakh has been recognised as revenue for the period from April 1, 2009 to December 31, 2009 and the balance amount of Rs 81,782 lakh has been carried forward and disclosed as deferred revenue in the balance sheet.”

From a pure accounting angle, the treatment seems in line with the principle of matching revenue with expenses. Since the company will incur expenses in the future in the execution of the contract at the now reduced rates, the amortisation seems in order.

However, the amortisation uniformly across the contract term seems odd, unless the revenue is spread uniformly in the future and the reduction impacts the company similarly.

However, the bone of contention is the one-time payment received, which is also “unconditional, irrevocable and non-refundable,” that is similar to the payment by the company. Why the difference in treatment? Will the company and its auditors come clean on that?
Queering the pitch further is the fact that the payments are certainly to Tech Mahindra’s associate company British Telecom (BT), which has a different take on the accounting. BT has accounted the equivalent of Rs 440.1 crore (GBP 55 million) and the notes indicate that GBP 28 million is income and the rest is prepayment.

While a general argument can and will be advanced that the treatment by BT will not dictate the accounting by Tech Mahindra, in this case it sounds far-fetched due to the close association of the parties. If the payment is one-time and non-refundable and is only for a window of negotiation, how can it be normal revenue for BT? There is certainly something amiss there.

Coincidentally, the amount paid over the two years is Rs 965.1 crore (Rs 525 crore + Rs 440.1 crore) and the amount received back is Rs 968.2 crore.

It is a matter for conjecture that the payment could be a financial support to BT and repaid with some compensation (or is it just exchange differences resulting in the difference) and was structured as such to sidestep FEMA regulations or other legal impediments? Is BT arm-twisting the company, being the largest shareholder and the largest customer as well?

It would be interesting to see whether any regulatory agency would initiate an enquiry into the same, on the lines of the SEC in the US, and force the company to come clean on the matter and where necessary force it to restate the accounts?

The writer is a chartered accountant.