Kingfisher Airlines and going concern

The airline entrepreneur David Neeleman once said, “A lot of airlines have come and gone.” The qualification of the ‘going concern' concept by the auditors to Kingfisher Airlines (KFA) spooked already-jittery shareholders. While it was public knowledge that airlines in general, and KFA in particular, weren't financially robust, questioning the viability as a ‘going concern' was surprising to them. It appears that the airline was of the opinion that they had only hit an air-pocket, while the auditor is of the opinion that the airline is in dire straits. Compounding the woes was the report of a Canadian research firm, which minced no words in concluding that KFA is teetering on the verge of bankruptcy and is close to insolvency.

COST-INTENSIVE

The airline industry, in general, isn't capital-intensive but cost-intensive. Jet fuel costs, lease costs and top-bracket salary costs recur with unerring regularity. When the Director General of Civil Aviation opened up the skies to private players, many players got in, keen to fly keener Indians. With a strategy to wean away the first-class rail traveller from the stations, ticket costs had to be kept affordable.

The fledging sector has already seen consolidation — Air Sahara was picked up by Jet Airways and Indian Airlines and Air India became one. Paramount Airways had to be grounded for some time due to the strain of costs, resulting in an inability to pay lease rentals on time.

An earlier airline attempt by the group running KFA, called UB Air, couldn't be on air for a very long time. Other airlines such as Damania and NEPC Airlines were grounded. Using marginal costing to price tickets was considered a ‘no-no', since the airlines assumed that the volume game would more than recover costs, once critical mass was achieved.

This never happened, as the results of KFA reflect. Out of total ticketed revenues of Rs 6233 crore, operating expenses ate up 39 per cent, fuel 37 per cent, aircraft and engine leases 16 per cent and employees 11 per cent, making KFA operationally negative. Secured and unsecured loans are almost 3 times the share capital plus reserves, while current assets are negative, reflecting the overhang of current liabilities. Rs 5348 crore of unreversed losses sit uncomfortably on the Balance-Sheet. The above was sufficient to convince the auditor that KFA's continuity as a ‘going concern' needs to be ascertained.

News of defaults in payments to a few airport authorities would have added to the impression. KFA would counter that a reduction in losses, as compared to the previous year, 366 domestic and 28 international flights, increasing revenues and a reasonable brand image can counter any argument, questioning the ‘going concern' concept. KFA also worked out a ‘debt recast' package with its lenders, which primarily involved converting loans from bankers and promoters into compulsory convertible preference shares, and loans from business associates into optionally-convertible debentures.

QUALIFYING AND REVERSING

The ‘going concern' concept directs accountants to prepare financial statements on the assumption that the business isn't about to go broke or be liquidated.

So, unless there is significant evidence to the contrary, accountants will base their valuations and their reporting of financial data on the assumption that the business will remain in existence for an indefinite period. As this is purely a judgemental decision, reporting practices differ. Some auditors in the United Kingdom have been known to qualify their report, questioning the concept of ‘going concern', if a major loan, on which the auditee is dependent, isn't renewed.

The auditors of a petrochemical company in South India have qualified their report, stating: “The ability of the company to continue as a ‘going concern' is dependent on the successful implementation of the rework package approved by ARCIL and other financial institutions through CDR mechanism, as referred to in the notes and recommencement of operations of its nitrogenous fertilizer plants. However, the financial statements have been prepared on a ‘going concern' basis.”

A ‘going concern' qualification is not irreversible. This would be possible only through big-ticket transactions, a large equity infusion, cashing in on uncashed assets, and, maybe, even renegotiating the terms of lease arrangements. The management of KFA has indicated that they intend to make their assets work more which would result in revenue accretions. Such transactions usually take time, and their feasibility would depend on the staying power of an organisation, which, in itself, is an indicator of a ‘going concern'.

(The author is a Bangalore-based chartered accountant.)

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