My Views on LPRC’s Third Quarter Financial
Results
By: Eric S. Kaba, CPA
The
Perspective
Atlanta, Georgia
February 2, 2007
Let’s assume that Mr. Greaves managed the newspaper in the United States of America (which he probably did) and that the company was taxpayer-owned (which probably was not). If a taxpayer or for that matter any party in the United States had raised questions or concerns of any kind about the newspaper Mr. Greaves managed, would he have given the same arrogant and combative response? I seriously doubt it because Mr. Greaves would be doubly aware that such behavior would raise the ire of the American taxpaying public. And he would not want to risk the possibility of losing his job. While I will not dwell on this aspect of the subject, I will like to remind Mr. Greaves and all others who serve in similar capacities in Liberia that the heat they feel from questions, criticisms, and suggestions about how they conduct the duties of their offices is a necessary consequence of their decision to hold those offices. If an individual feels that he or she does not owe it to the Liberian people and nation to answer questions, respond to criticisms or give explanation in a calm, coherent and professional manner then that person should not hold public office. Indeed, I am amply aware of how equally combative and seemingly arrogant some of the questioners and critics can be but that is what distinguishes a democratic society from a totalitarian one. In a democratic society people have a right to know and by no strange measure they often try to know by asking questions and by sometimes even criticizing the people who represent them and/or their interests.
GENERAL CONSIDERATIONS
Part of the reason why a lot of people continue to ask
questions and have reservations about how LPRC is conducting
business lies with the unexplained and therefore dubious
conditions surrounding the crude oil contract the Corporation
said it entered into with the Nigerian government and
Addax Ltd. The lack of clarity and information about
the contract leaves one no choice but to have questions
about what it is and what is its nature. For example,
could it be that the Nigerian National Petroleum Corporation
(NNPC) produces the crude oil under the contract with
LPRC and Addax refines and transports the product(s)
to Liberia? Or is it that NNPC gave permission to Addax
(in accordance with bilateral arrangements between the
Liberian and Nigerian governments) to sell refined petroleum
products to LPRC? But if this is the case then why does
LPRC say it buys 10,000 barrels of crude oil a day as
opposed to saying it buys a number of gallons of refined
products (such as various grades of gasoline)?
If LPRC entered into a one-year contract with the Nigerian National Petroleum Corporation to buy 3,650,000 barrels of crude oil then how is it that LPRC had to enter into another contract with Addax Ltd. to “manage and operate the NNPC contract”? Note that Addax Ltd. is said to be the largest independent oil producer in Nigeria, according to LPRC, not a crude oil contract management entity. Even though it is possible that Addax could also be a crude oil contract management firm in addition to whatever else it does as a business entity, the explanation given to the public does not make mention of Addax Ltd. as a crude oil contract management entity. Or does “manage” as used in the LPRC report have a different meaning from the ordinary definition of the word?
And then there is the difference between crude oil and the products that are extracted from it, from the production and consumption point of view. A barrel of crude oil is equal to about 42 gallons of crude oil. Here are some of the by-products of a barrel of crude oil, per data from the American Petroleum Industry (API):
19.5 gallons of 87 octane (regular unleaded) gas
11.50 gallons of distillate and residual fuel oil
4.1 gallons of jet fuel
3.80 gallons of liquefied and still gases
0.2 gallon of kerosene
1.3 gallons of asphalt/road oil
0.5 gallon of lubricants
1.2 gallons of feedstock (used mainly for making plastic
products).
It should be noted that according to the API data, total by-product yield per a 42-gallon barrel of crude oil can exceed 44 gallons due to what is referred to as “processing gain”. This means that a refining process that starts with 42 gallons of crude oil and may end up with 44 gallons of refined products of various types as mentioned above. I guess by now you are wondering why I am bothering you with all this information. According to the narrative that accompanied LPRC’s third quarter 2006 financial statements, the company “buys” 10,000 barrels of crude oil a day. Note the emphasis on the word BUY. Here is the specific language:
“In its quest to find additional sources of revenue, the corporation’s board authorized the management to enter into a one-year contract with the Nigerian National Petroleum Corporation (NNPC) to buy 10,000 barrels per day of crude oil.”
Since LPRC said it buys 10,000 barrels of crude oil a day, the following questions are appropriate: (1) Who refines the crude oil? (2) Is it NNPC or Addax? (3) Where is the oil refined? The information I have about Nigeria’s capacity and ability to refine crude oil is that such capacity and the attendant technology are so limited that the country relies on refineries in countries as far away as Holland to provide refinery services and/or refined petroleum products; (4) Does LPRC own all the by-products that are produced through the refining process? (5) If yes, where are those other products (beside gasoline, fuel oil and kerosene) sold and was any revenue from their sale or exchange reported on the third quarter 2006 financial statements? I ask this question because clearly Liberia, given its current economic and industrial state, cannot fully utilize all of the by-products that the crude oil refining process yields; (6) Since the LPRC Board of Directors authorized the purchase of 3,650,000 barrels of crude oil as a means to “find additional sources of revenue”, according to the information LPRC published, what are the principal sources of revenue for the Corporation beside the revenue that is expected from the 3,650,00 barrels of crude oil transaction? And (7) where on the income statement is this revenue reported?
ACCOUNTING CONSIDERATIONS
Even though the narrative to the Corporation’s
financial statements states that the company buys barrels
of crude oil, the income statement does not show revenue
from the sale of a product or cost of sales. Were it
not for the use of the word BUY in the entity’s
report the obvious reason would have been that LPRC
does not incur production costs (because it does not
produce anything) nor does it purchase the petroleum
products (as would be under a merchandise-for-sale scheme).
Even though the company is called the Liberian Petroleum
Refining Company, it apparently does not do any refining,
at least not under present conditions. It is both puzzling
and ironic that a business entity BUYS an item (crude
oil) and yet does not show revenue from sales nor does
it show cost of sales. What happens after LPRC “buys”
the crude oil? Is it that the Corporation merely has
the right to purchase 10,000 barrels of crude oil a
day but that this right is in fact exercised by another
business entity (perhaps Addax Ltd.)? The information
from the financial statements and other sources seems
to imply that LPRC merely provides services: perhaps
unloading of refined petroleum products, transportation
services (from the point of unloading to storage tanks)
and storage facilities. The “revenue” LPRC
earns appears to come principally from the fees it charges
to handle and store the refined petroleum products.
It also seems like the items (which can be referred
to as inventories of petroleum products) stored in LPRC’s
tanks are there on consignment. This would mean that
Addax Ltd. ships and stores refined petroleum products
in LPRC’s storage tanks over which it (Addax Ltd.)
retains ownership; LPRC sells the consigned “goods”
to local and other merchants who in turn sell the products
to consumers. The evidence of this is found in the fact
that (1) the Corporation does not list any inventories
on it balance sheet and (2) it does not show cost of
sales (as mentioned earlier); cost of sales normally
includes both beginning and ending inventories, if there
are any.
A useful and complete professional analysis of LPRC’s third quarter 2006 financial statements is nearly impossible for a number of reasons. Among them is one very significant one, namely the absence of footnote disclosures. [NOTE: I did not see any footnotes when I downloaded the document from theperspective.org web site. Perhaps they are somewhere there but I did not and still do not see them.] Here is a brief look at why footnotes would have helped a lot, especially since LPRC chose to publish its financial statements in the forum and manner it did.
As other people have indicated before, footnotes help provide additional information and disclosures about key items and amounts reported on a set of financial statements because such information is normally not evident from the numbers on the statements. For example, a footnote about an accounts receivable on the balance sheet may disclose the portion that is receivable from government agencies and the portion that is receivable from the public at large. The absence of footnote disclosures cannot be excused or explained away on account of the fact that the financial statements are quarterly reports. When a business entity undertakes to publish its financial statements, like LPRC did, it has (at the very least) a moral responsibility to provide the reading public and other interested parties the information and disclosures they need to gain a meaningful understanding of the information contained in those financial statements. In the event an entity is unable to provide accompanying footnotes to its financial statements, it is - at the minimum - desirable that the entity clearly states so and gives a brief explanation of its inability to disclose information in footnotes.
Had LPRC provided footnotes the reading public would have been able to gain a better understanding of such items as accounts receivable (as mentioned above), fixed assets, short and long-term liabilities, “other revenue” and “other operating expense”. For example, the Corporation reported accounts receivable in the amount of $1,546,705 but there was no indication on the balance sheet (via reference to a note to explain) that this amount was net of an allowance for uncollectible accounts. Even if LPRC thinks it will collect every penny owed to it on those accounts, the accounting concept of conservatism requires that receivables be reduced to account for the likelihood that a portion of the receivables will not be realized; and the matching concept ensures that uncollectible accounts expense is properly matched to revenues in the period in which those revenues are earned.
Perhaps LPRC employs the direct write-off method of treating accounts receivable. However, because this method does not port well with the concepts of conservatism and matching, the allowance method is more widely used and preferred. Another reason why the direct write-off method lacks appeal among both financial and accounting professionals is that it can be used to manipulate the presentation of financial information. For example, an entity that wants to show a good balance sheet and higher net earnings on its income statement can very conveniently employ the direct write-off method. The reason is that it can report inflated receivables on the balance sheet (and correspondingly inflated earnings on the income statement because of the absence of a deduction for uncollectible accounts expense). In the interest of fairness, one could assume that the accounts receivable figure reported on LPRC’s balance sheet is in fact net of an allowance for bad debts and that the corresponding uncollectible accounts expense is buried in (perhaps) “Other Operating Expense” on the income statement”. But the absence of relevant footnotes to convey this information makes this assumption almost irrelevant.
The absence of footnotes also presents a meaningful disclosure problem for a very important item on LPRC’s balance sheet, namely “Other Fixed Assets” in the amount of $9,005,318. “Other Fixed Assets” account for 74 percent of the Corporation’s assets. A footnote disclosure for this item would have shown to readers and others the cost incurred to acquire the assets, the types of fixed assets, their estimated useful lives and perhaps more importantly the method or methods of depreciation used to amortize the acquisition cost of those fixed assets. Assets useful lives are also very important and can affect financial statement presentation. However, I will not go into that for the mere fact that the asset useful lives that companies use for depreciation purposes generally tend to be in line with the type of assets involved and the established precedents their industry follows. I will instead elaborate on the method or methods used to depreciate fixed assets.
Why is the method used to write-off the cost of fixed assets important? Well, again we go back to the possibility of or inclination to manipulate information that is presented in financial statements. Some depreciation methods allow for a slower write-off or amortization of acquisition costs while others permit a faster approach. If a company wants to present a good and appealing balance sheet and income statement, it will employ the slower method(s) of depreciating its fixed assets. From the income statement point of view, the reason is that the amount of depreciation expense will be smaller and therefore net profits will be higher (or net losses will be smaller). On the balance sheet, the higher net profits (or smaller net losses) will boost equity through their effect on retained earnings or cumulative results of operations. Also, a slower (as opposed to an accelerated) method of depreciation results in higher net fixed asset carrying values on the balance sheet because accumulated depreciation figures are smaller or low.
CONCLUSION
Does the management of LPRC employ accounting methods
that are specifically targeted to make for an attractive
set of financial statements? I do not know the true
answer to this question but I do know that the Corporation
could have done a lot better to provide information
necessary to give readers (and doubters) little or no
reason to believe that its third quarter 2006 financial
statements appeared or might have been unreliable. Also,
from the professional point of view, good managers try
to avoid the appearance of impropriety in both the functions
of their business entities and in the acts they personally
engage in as they represent those entities. One good
way to avoid situations where it looks like something
improper has happened or is happening is to provide
as much clarity and transparency about business transactions
and activities as possible. Managing Director Harry
Greaves had the opportunity to provide a measure of
clarity and transparency relative to LPRC’s third
quarter 2006 financial results when he responded to
Mr. Francis K. Zazay’s article but he instead
chose to let it be known that he is not accountable
to anyone and that he can put up a fight. One wonders
whether Mr. Greaves is (a) an incompetent public servant
and manager as evidenced in part by his lack of willingness
to accept criticisms from the public whose interest
he is supposed to serve and represent, (b) is hiding
something or (c) a combination of these two vices.