Financial Reporting & Analysis

A case study on changing depreciation methods and quality of

disclosure

Team 7:
• Debsmita Mitra (1914048)
• Nitesh Kumar Jain (1914028)
• Rahul Dengra (1914019)
Ravi Shankar (1914062)
• xxxx
• Sakthivasan (1914005)
XXXX
 Table of Contents
1. About Lanco Infratech

2. Debrief of the case study

3. Questions from the case study

4. Answering questions from the case study

2 Indian Institute of Management, Bangalore | FRA Case Study | Team 7

 About Lanco Infratech Debrief of the case study Questions from the case study Answering questions from the case study

Lanco Constructions Ltd. was incorporated in Mar 1993 in Hyderabad

Name changed to Lanco Infratech Ltd. in 2000

A construction and infrastructure development company

Engaged in construction development sector for execution of:

• Various civil contract works
• Power sector projects through its group entities
Divisions of the company: Construction & EPC, Power, Infrastructure and Property
Development

Case Study focuses

on Q2 to Q4 2011
Share Price Changes
of the Company

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About Lanco Infratech Debrief of the case study Questions from the case study Answering questions from the case study

Timeline of key events

1993 2000 2006 2010 2013 2017

Incorporation Renamed Went Public Became Slashed its staff Faced

of the from ‘Lanco largest private strength by insolvency
Company Constructions power ~50% (from proceedings,
Limited' to ‘Lanco provider in about 8,500 in with Indian
Infratech Limited' India 2010-11 to National
about 4,500 Company Law
2013) Tribunal
suspending the
board

Lanco was one of the first Independent Power Producers (IPP) in India

4 Indian Institute of Management, Bangalore | FRA Case Study | Team 7

 About Lanco Infratech Debrief of the case study Questions from the case study Answering questions from the case study

Observations from the case study

In Q2 FY11
EBITDA:
• Revenue increased by 6% over Q2FY10
• Cash Profit went up by 61% year on year
• EBITDA went up by 47% year on year
• Net Profit of ₹705 million, a decline of 43% over Q2FY10
• Depreciation charge increased 4 times to ₹1703 million
• Increase in depreciation due to change in Depreciation
method from SLM(₹498 million) to WDV(₹1370 million)
• The charge for Q2FY11(₹1703 million) was half of that
for FY10 (₹3479 million)
Cash Profit:

The increase in depreciation charge was despite a smaller growth

in the fixed assets
5 Indian Institute of Management, Bangalore | FRA Case Study | Team 7
About Lanco Infratech Debrief of the case study Questions from the case study Answering questions from the case study (i)

Questions from the case study

1. What was the justification for the change in the depreciation method?

2. In your view, why did the company change the depreciation method?

3. What was the effect of the change in the depreciation method on the profit for Q2FY11 and for the
year ended March 31, 2011?

4. Comment on the quality of disclosure of the effect of the change on the profit

5. The company’s spokesperson said that the company opted for higher depreciation in order “to
conserve cash.” What was that supposed to mean?

6 Indian Institute of Management, Bangalore | FRA Case Study | Team 7

About Lanco Infratech Debrief of the case study Questions from the case study Answering questions from the case study (i)

Justification given by Lanco for the change in depreciation method

Mr. J Suresh Kumar, Chief Financial Officer of Lanco Infratech:

“We consciously opted for higher depreciation to conserve cash even

though this shows lower profits. But the cash profits have been good and
we expect to do better in the coming quarters with fresh capacity coming
up in the power sector.”

7 Indian Institute of Management, Bangalore | FRA Case Study | Team 7

About Lanco Infratech Debrief of the case study Questions from the case study Answering questions from the case study (ii)

Justification for the change in the depreciation method: Our View

• In anticipation of short term tariffs to go higher (to better match higher revenues with higher
expenses)

• Lanco took a hit in Net Profit for Q2FY11 by increasing depreciation expenses. In future
quarter, the depreciation expense will be lower and they will be able to show higher profit
than the actual, if there was no change in depreciation method

Changing the Depreciation Method: The depreciation method should reflect the pattern in
which the enterprise expects to consume the future economic benefits from the asset. New
information could suggest a different pattern. The method must be reviewed at each reporting
date. If there is a significant change in the pattern of consumption of the future benefits, the
enterprise must change the method to reflect the new pattern. Appropriate disclosures are
required

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 About Lanco Infratech Debrief of the case study Questions from the case study Answering questions from the case study (iii)

Effect of change in depreciation method on the profit for Q2FY11

and for the year ending Mar 31, 2011
Q2 FY11 Cash Profit:
• Less Profit due to higher depreciation expense
• Lanco Infratech was able to justify, with explanation, that
cash profits were still higher, and that profit has reduced
driven by change in depreciation method only

Cash Profit:
Year ending Mar 31, 2011
• Lanco Infratech reported a profit growth of 54 per cent for
the quarter ended December 2010
• However, stock price fell by ~17% in a single day
• Driven by the profit that was inflated by the change in
depreciation method again this quarter
• If this change were excluded, profit growth year on year
would be lower by 70 per cent

9 Indian Institute of Management, Bangalore | FRA Case Study | Team 7

About Lanco Infratech Debrief of the case study Questions from the case study Answering questions from the case study (iii)

PAT decreased by 3%: Depreciation increased only by ~2%, and

Interest and Finance Charges increased by ~113%

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 About Lanco Infratech Debrief of the case study Questions from the case study Answering questions from the case study (iv)

Comments on quality of disclosure of the effect of change on

the profit

The reported consolidated Net Profit has been arrived at after charging an amount of:
• ₹13,704L towards depreciation under Written Down Value method, while under Straight Line Method,
the depreciation provision should have been only ₹4,976L for the quarter ended Sep 30, 2010
• ₹26,062L towards depreciation under Written Down Value method, while under Straight Line Method,
the depreciation provision should have been only ₹9,516L for the half year ended Sep 30, 2010

The disclosure was not adequate as only the details of what changes were made was provided but there was no
transparency regarding the exact reason

Public had to rely on the analyst’s view or speculate for the exact reason for change

11 Indian Institute of Management, Bangalore | FRA Case Study | Team 7

 About Lanco Infratech Debrief of the case study Questions from the case study Answering questions from the case study (v)

Company spokesperson – The company opted for higher depreciation

in order to “conserve cash”

It is a myth that change in depreciation method directly impacts the cash flows

Depreciation is a tax-deductible expense and can reduce tax cost  Can have impact on cash flow indirectly

Only if there is sufficient taxable income to absorb the depreciation  Applicable to say that a company can
conserve cash using depreciation

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Questions & Answers

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