Hideaways in accounting

THE stock exchange, the Hong Kong Society of Accountants and, no doubt, the financial services branch of the Government are working on issuing a new set of accounting standards.

They are rightly concerned about whether the accounts of public companies give investors a true and accurate picture of company performance.

There are particular problems in the way that some companies throw extraordinary and exceptional items into their above-the-line (or normal) profit and loss account.

This can often be highly misleading and can distort the earnings record. The first Unfinished Business column looked at the way in which Hopewell Holdings has consistently used property disposals to boost its earnings record when, in reality, it has been reducing its earnings base.

Chuang's China Investments has a similar problem regarding normal earnings, which will recur as part of the business from extraordinary earnings arising, in the company's case, from property disposals.

Chuang's started life as a cosy family business manufacturing watch bands. It has since become a substantial investor and property developer in China. In a full-page newspaper advertisement last Thursday, Chuang chairman Hwang Jen announced that 1992/93 had been ''a year of substantial achievement in which the foundation stones were laid for the future''.

According to the company, it turned around from a $17.1 million loss in the year ending December 31, 1991, to a profit of $104.7 million in the year to March 31, 1992.

Nowhere was it stated, although the company was prepared to supply the information in response to an enquiry, that $76 million of the increased profit was attributable to the disposal of Chuang's non-China properties.

The company believes that its future lies in the development of Chinese mainland properties - a brave view in current circumstances - and that these developments can be funded by disposal of assets elsewhere.

Sales like these clearly produced income of an exceptional nature, although the company insists that these properties have always been considered as investment properties and, therefore, should be included as a normal part of its business.

Interestingly, however, the company does make allowance for a $18.1 million gain on another property disposal, which is treated as an extraordinary item and is tucked below-the-line.

However, the confusion surrounding Chuang's accounts does not end there because the losses of the previous year, described in the accounts as ''exceptional loss on relocation of production facilities'' to China are, nevertheless, included above-the-line to the tune of $2.2 million.

It is possible to argue that a more accurate view of Chuang's earnings record would be that it suffered a loss of $14.9 million in 1991 and a profit of $28 million in 1992/3. Such a result is rather less spectacular than the reported $17.1 million loss, transformed into a $104.7 million profit.

HOWEVER, even these figures fail to tell the whole story because Chuang's has decided to change the month of its reporting year and so was reporting results for 15 months last year.

The company is perfectly entitled to change its year-end, but is also obliged, if it really wants to keep shareholders informed of its affairs, to produce a pro-rata account comparing the two 12-month periods.

As matters stand, investors are having to compare Chuang's performance over 12 months with its showing in a 15-month period.

Incidentally, they might also like to know how such a modest real profit increase was achieved in the face of a significant turnover increase, from $273 million in 1991 to $858 million in 1992/3.

It is to hoped that Chuang's' shareholders will be able to get a much clearer picture of the company's earnings under the stock exchange's new accounting rules.

Last week, Paul Phenix, the exchange's director of compliance, confirmed that the treatment of extraordinary items, and prior period adjustments, would be included in the rule changes.

The Hong Kong Society of Accountants is adopting a vigorous stance in this matter. It would, among other things, ban the gain on sale of investment properties from appearing above-the-line in the profit and loss and account.

Indeed, it has a wide definition of which types of exceptional gains it would like to see banned from appearing above the line.

Lamentably, however, nobody is suggesting banning the practice of issuing bonus shares.

Celebrating their supposed good fortune in the past year, the Chuang's directors proudly unveiled a one-for-five bonus share issue.

Do bonus shares offer shareholders better dividends? No, they do not. But they instantly dilute earnings per share.

Do bonus shares increase investor's holdings? Absolutely not. They merely divide the cake more thinly.

So what do bonus shares achieve? In a word, nothing. However, companies like to issue these shares because it costs very little, apart from a bit of administration, and it sounds ever so generous.

In reality, shareholders are being given back their original shareholding, albeit re-packaged to look better.

It should be stressed that Chuang's' is not alone in this practice. A host of perfectly respectable companies are regular practitioners of bonus share issuing.

Near the top of the list is the dour Hang Seng Bank, which issues bonus shares regularly.

Finally, it is worth - in the light of the controversy over the Sincere directors' pay - looking at how Chuang's directors decided to reward themselves last year as the company slid into the red.

They decided to almost double their emoluments from $940,000 in 1990 to more than $1.7 million in 1991.

The annual report is awaited to reveal how they have been rewarded, following last year's results.