GROUP MEMBERS

MAYANK TALWAR

RAJWINDER PURI ROHAN KIR

PARTHA SARTHI ROUT

ANSHUL CHHABRA

ABOUT THE COMPANY

Oil and Natural Gas Corporation Limited (ONGC) (incorporated on 23 June 1993) is a state-owned oil and gas company in India.

It is a Fortune Global 500 company ranked 152nd, and contributes 77% of India's crude oil production and 81% of India's natural gas production.

It is the highest profit making corporation in India. It was set up as a commission on 14 August 1956.

In 2009, cos. Revenue was $21.5 bn and it had Total Assets worth of $37.3 bn.

ANALYSIS OF CHANGE IN ACCOUNTING POLICIES OF

ONGC

Information regarding ONGC’s reported profit, in millions, for four financial year as follows:

ONGC’s accounting policies up to the year ended March 31, 1985 were as follows:a. Expense all geological and geophysical survey costs in the year in which they were incurred.b. Capitalise exploratory drilling cost and

i. Expense 1/5 of the expenditure in respect of areas for which the success or failure of the exploratory effort has not been determined;

ii. Expense 1/3 of the exploratory drilling expenditure net of amortization as stated in (1) above in respect of areas in which the exploratory effort was determined to have failed from the year in which it was decided to surrender the area; and

iii. Transfer to Producing Property account all exploratory drilling cost net of amortization as stated in (1) above in respect of areas declared as commercial producers.

1984-85 1985-86 1986-87 1987-88

Net profit Rs. 8,820 Rs. 13,020

Rs. 14,840

Rs. 15,080

c. Capitalise all developments drilling expenditure as part of Producing Property along with the exploratory drilling expenditure as stated in (b) (3) above and deplete in 10 equal instalments beginning the year when the area was declared a commercial producer regardless of the level of production. Subsequent development drilling costs were capitalised and expensed in equal instalments in the balance years remaining to complete 10 years from the year of commercial production.

d. Capitalise all costs incurred on erection/installation of production of production facilities such as flow lines, group gathering stations, production platforms and other facilities such as flow lines , group gathering situations, production platforms and other facilities up to a delivery point. These costs are depreciated as per rates provided in the Income Tax Act and rules following the diminishing balance method. Depreciation on the facilities up to the date of commercial production was capitalised as part of the development cost of the field and ultimately as part of Producing Property and expensed as indicated under (c) above. Depreciation from the year of commercial production was expensed in the year of commercial production was expensed in the year in which it was charged.

e. Capitalise at cost plant and equipment such as trunk line, rigs, transport, survey equipment, support facilities, etc. And depreciate at the rates provided in the Income Tax Act and Rules, following the diminishing balance method. Depreciation on transportation activity of crude or gas was expensed in the year in which it was charged while depreciation on other plant and equipment was allocated to exploratory or development activity and capitalised. This depreciation was expensed as a part of the exploration/ development cost as indicated under (a), (b) and (c) above.

f. Expense all replacement cost of plant and equipment in the year in which they were incurred.

It was felt that the above policies (b, c and d) resulted in understatement of fixed assets and did not take into account the need to spread the cost over the projected total production from the field. Also, the policies did not accord with international oil industry practices for charging such costs. Consequently, ONGC decided to adopt the successful efforts method and changed its accounting policies as follows:a. Geological and geophysical survey costs will be expensed in the year in which they were incurred, as per the existing policy.b. Exploratory drilling costs in areas declared unsuccessful and surrendered as at March 31, 1986 will be expensed net of amortization till last year.c. Exploratory drilling costs net of amortization till last year in respect of areas yet to be determined as unsuccessful or abortive (as at March 31, 1986) will be capitalized as Wells-in-progress.d. All accumulated exploratory drilling and development drilling costs in successful fields including related facilities such as flow lines, production installations and offshore platforms, already commissioned (as at March 31, 1986) will be capitalized.

The above costs have been taken net of amortization, depletion and depreciation already charged till last year. After considering the additions during the year, the costs have been expensed following the unit of production method by individual field/basin. The recoverable reserves have been taken as per the estimates by the Reserve Estimation Committee as at January 1, 1986 net of production in the first three months from January 1985 to March 1985. These reserves are limited to A, B, and C-1 category reserves. The audit report of the Controller and Auditor General of India (CAG) presented the following information regarding the effect of company’s accounting changes (amount in millions)

Nature of Expenditure

Charged to profit and loss account

Increase (+)Reduction (-)

Depletion Rs. 4,174.5 Rs. 1,466.5 Rs.(-) 2708.3

Depreciation 4,744.0 2,177.6

(-) 2566.4

Amortization 2,539.2 2,717.3

(+) 178.1

Total 11,458.0 6,361.4

(-) 5096.6

The CAG’s report observed:The successful efforts method requires appropriate administrative practices under which abandoned areas are declared as such without any delay and even in areas under exploration the expenditure incurred on dry wells is immediately expensed. The present head of account ‘wells-in-progress’ includes the cost of many dry wells. Non-expensing of the cost of dry wells has thus resulted in understatement of expenditure and overstatement of profits (extent not ascertainable) Under the new policy, the depletion has been computed by multiplying the total production by the unit rate of production which is arrived by working out the ratio of total investment in producing properties and production facilities over the total estimated recoverable reserves. The manner of computing the unit rate of production as adopted by the Commission has effect of depressing the total amount of depletion due to the following:a. The total recoverable reserves includes the reserves of C-1 category (which is only portable reserves).b. The total recoverable reserves are correlated with the investment actually required to extract the same.c. Cost of production facilities has been considered to be an investment without correlating the useful life of such facilities to the productive life of the reserves.

REQUIRED

1. Examine the impact of the accounting changes affected by ONGC in 1985-1986.

2. Who are the potential users of ONGC’s financial statements? How might they react to the change?

3. Identify possible managerial motives for making accounting changes. How far were they relevant in ONGC’s case?

4. Draft a note on the accounting changes for inclusion in ONGC’s report.

5. From the standpoint of users of financial statements, what safeguards are available against attempts by corporate management to make arbitrary accounting changes?

PROVISIONS UNDER GAAP

AS-6 does not apply to Wasting assets and Capitalization of exploration activities.

All the development costs which when identified as an asset should be capitalized.

Wasting assets are to be depleted as per usage of the assets in a particular year.

Impact of Accounting Change-• After implementing changes the profit of ONGC has increased by

Rs.5096.6 million due to reduction in expenditures related to Depletion, Depreciation and Amortization as given by CAG’s Audit Report.

• This was evident when after the policy changes in 1985-86, the N.P. increased drastically from Rs. 8820 mn to Rs. 13020 mn and then increased with a much lower rate in subsequent years.

• The increase in profits was due to understatement of expenditure, the extent of which is not ascertainable.

• So the scenario before changes was showing rosy picture of ONGC as profits shown were overstated.

INTERPRETATION

The profits of previous years were understated.

The assets were overstated.

Users and their reactions:

Potential users of ONGC’s financial statements are:

1. Government2. Financial institutions/ Investors3. Shareholders4. Lenders/ Suppliers

Different users will react differently to the changes made in accounting policies of the company.

GOVERNMENT

The new policies are in line with the govt. policies of depreciating the wasting assets.

The increase in profits would have lead to increase in the tax revenue to the govt. in earlier years.

FINANCIAL INST. AND/OR POTENTIAL INVESTORS

Increase in profits would have lead to a reassessment of the position of the co. in their portfolio.

Hence, the market capitalization of the co. would have definitely increased.

SHAREHOLDERS

The expectation of the shareholders would have risen.

It would have lead to higher dividend at least in absolute rupee terms.

The increase in earnings also could have lead to an advancement up the ladder in the tax bracket of the shareholders. So, they could have taken this as negatively.

SUPPLERS

Suppliers are comfortable to supply goods to a profit making co. as high profit making feature is considered synonymous with higher liquidity, efficiency and solvency.

So, the co. would have achieved a better bargaining position vis-à-vis their suppliers.

Improved credit ratings

Managerial motives for making changes:

• Better disclosure of the Financial Picture of the co.

• To accord with international oil industry practices

Although the company’s intention of changing the policies to accord with international oil industry practices is good but in the process it shows the profits which are overstated and likely to translate that into higher taxes.

So, managerial motives for making changes are relevant to certain extent only.

Note on Accounting Changes:

Accounting changes effected by ONGC should be included in ONGC’s financial report as it is necessary to show any changes implemented by the company to safeguard the interests of various users of the company.

To show the fair and true position of the company .

Reasons for a potential conflict

Special treatment of the wasting assets and the non application of the AS-6 to exploration related assets.

The need for further declarations and clarifications. For e.g. In what circumstances is the exploration considered to be a success/ failure, etc.

Safeguards:

The various users of financial statements can protest against arbitrary accounting changes made by corporate management if they are not in accordance with the guidelines issued by ICAI, SEBI etc.

There may be following Safeguards-

• A Valid justification to change the accounting procedure.

• Compliance with the guidelines of ICAI, SEBI, etc.

THANK YOU