How Diverse are Accounting Practices for IPO Profit Guarantee Shortfall?

Abstract

IPO profit guarantee was prevalent among companies going public on the Second Board in Malaysia during 1996-1999, whereby the major shareholders provided guarantee to the IPO investors that the forecasted and projected profits of the company would be achieved over the next three years following listing. Following the Asian financial crisis in 1997-1998, shortfalls in guaranteed profits were pervasive. This study documents that out of 103 companies with IPO profit guarantees, more than 40 percent reported shortfalls. Examining the annual reports of the companies with shortfalls reveals that the accounting practices to account for the shortfalls are quite diverse although they are generally in line with the applicable accounting standards. The common approach is to immediately disclose the shortfalls (without accruing them) as contingent assets when they become probable of collection. Equally common is the method of recognising the shortfalls (either immediately or delayed) by crediting retained earnings when compensations for the shortfalls become almost certain. There are also cases, although very few, of companies not making timely or any disclosure which contravene the Listing Requirements of the Kuala Lumpur Stock Exchange.