Washington Gikunju
4 February 2010
Had KenGen adhered to provisions of the International Accounting Standards (IAS) while preparing its financial statements for last year, it would have reported a pre-tax loss of Sh894.6 million.
But the management decided to change the company's accounting policies, departing from IAS 21 which provides that companies should charge all exchange losses resulting from foreign currency denominated transactions in the income statement.
Instead, KenGen recognised the foreign exchange losses of Sh5.3 billion incurred in 2009--which represented a 278.6 per cent increase from the previous year's figure of Sh1.4 billion-- in a special "foreign currency revaluation reserve account" in the company's statement of changes in equity.
The effect was that Kenya's biggest power generating company reported a Sh4.6 billion pre-tax profit in the financial year ended June 2009, a 48.4 per cent growth over the earnings announced in 2008.
"Applying IAS 21 would have been misleading, the international accounting standards are just a guide that management is not necessarily compelled to comply with," said KenGen managing director Eddy Njoroge in an interview early this week.
It is true that the international financial reporting standards give leeway to the management teams of specific companies to deviate from the IAS guidelines in special circumstances.
The caveat however is that companies that depart from the guidelines must disclose such deviations in their annual statements, revealing also the impact of the policy change in the accounts of the firm and giving reasons justifying the alterations.
Mr Njoroge says its would be misleading to continue charging currency exchange costs in KenGen's income statement as all losses are now recoverable from the consumers by way of a pass-through cost in the power bills known as a foreign exchange rates fluctuation adjustment (FERFA) charge.
Instead, the KenGen management team saw it more appropriate that the unrealised exchange rate losses should be reflected in the statement of changes in equity, while recoveries collected from consumers through KPLC should be offset against the realised losses in any particular year.
The Energy Regulatory Commission (ERC) in July last year cushioned all companies involved in generation and transmission of electricity from currency fluctuation losses arising from commercial transactions, asset valuations and borrowings that are done in foreign currencies- making such losses a recoverable item from consumers for the next three years.
KenGen and electricity distributor the Kenya Power and Lighting Company (KPLC) also signed a 20-year power purchase agreement (PPA) that is only subject to periodical reviews that will cater for emerging variables in the cost of generating and transmitting electricity.
"The PPA and the gazette notice that ERC passed following signing of the PPA gave us the legal backing to change our accounting policy in the manner that we did," says Mr Njoroge.
It was not a straightforward decision for KenGen though, as our enquiries revealed.
The company's finance team did a lot of soul searching and head scratching and had even to contact market regulators the Capital Markets Authority (CMA) as well as the Institute of Certified Public Accountants of Kenya (ICPAK).
None of the two bodies was committal on whether or not KenGen's action was a fundamental breach of the accounting code, or whether it would mislead investors who relied on the firm's financial statements in future.
"The Authority investigated this matter," said CMA chief executive Stella Kilonzo in an interview. She said the capital markets watchdog then referred the matter to the accountants' regulatory body, ICPAK."
ICPAK also did not have a ready answer, and it escalated the issue to the International Accounting Standards Board (IASB), which also admitted that it did not have a position on this "peculiar" situation that required an interpretation of how accountants can treat reimbursable costs in their books.
In the end, all that CMA could do was to require that KenGen discloses to shareholders the material change in accounting policy.
"IAS 21 does not envisage recoverability and this is a matter we took into account," said Ms Kilonzo.
The ICPAK chief executive, Caroline Kigen, also gave a lengthy response to KenGen who had wanted to know the legality of their intended move, but ultimately left it to Mr Njoroge and his team to carry the burden of presenting users of the financial statements with accounts that represent a true financial position of the company.
"The IASB is currently looking into this issue and recently issued a new exposure draft for rate-regulated activities. We propose that you assist us in reviewing the exposure draft so as to enrich our comments to the IASB and ensure that it adequately addresses the foreign currency challenges faced by yourselves and other independent power producers in Kenya," said Ms Kigen in her response to KenGen.
Other experts chose to look at the moral justification for KenGen to pass on all its forex losses to consumers, arguing that it gives the management a dis-incentive from managing the firm's forex costs.
Firms in a perfectly competitive sector are ordinarily forced to take forward currency contracts as a hedge against future currency translation losses.
KenGen states in its financial statements that "It is not the company's policy to enter into forward (currency) contracts before any transactional commitment."
"KenGen has a contractual right to recover these losses from the consumers, and if that is the case, there could be a possibility to recognise a corresponding asset in the financial statements," says Ashif Kassam, a managing partner at RSM Ashvir, an audit, tax and financial consulting firm
"However, the certainty of the possibility of the recognition of the asset can only be determined by reviewing all the facts."