Sale of Reliance Industries shares by RIL’s Petroleum Trust

In the last few days, newspapers are full of reports on the sale of RIL’s shares by Petroleum Trust managed by RIL.

Many experts have commented about the impact of the transaction. RIL has also issued a communication saying “the financial impact will be reflected in the consolidated statement of the company.”

The reality is that the RIL Group has raised Rs 3,188 crore of cash from the sale. Reports on various uses of the cash, including investment in a global acquisition, are doing the rounds.

A bit of understanding of the background and the relevant accounting standards will help the readers reach the right conclusion as to how the transaction will impact RIL’s results.

First and foremost the legal entity, which sold the shares, is Petroleum Trust, and not RIL. Reliance Industries Investments and Holdings Limited, a 100 per cent subsidiary of RIL, is the sole beneficiary of Petroleum Trust. Hence the transaction will not be reflected in the standalone accounts of RIL.

However, consolidated accounts of RIL will reflect the transaction. This is in line with the RIL’s communication issued in this regard.

Transfer of shares

This leads to the critical question of s the meaning of “will be reflected in the consolidated statement of the company.” The popular understanding is that the profit will be credited to the P&L account. Before jumping to this conclusion, let us look at the facts and the relevant accounting conventions. Let us first look at how the shares came into the possession of Petroleum Trust.

Prior to merger of the earlier Reliance Petroleum and IPCL, RIL transferred its shareholding in the merged companies to Petroleum Trust. On merger, Petroleum Trust received RIL shares as per the approved exchange ratio. The other option RIL had at the time of merger was to cancel these shares. If this option had been exercised , RIL’s share capital would have been lower to the extent of the face value of the shares issued to Petroleum Trust and reserves would have been higher by an equal amount. There would not have been any impact on the P&L account.

In consolidated accounts, there is no difference between the holding and its 100 per cent group companies. Logically, no company can generate profit by issue of its own shares.

Sale of treasury shares by the group company is equal to the issue of own shares at a premium. Hence, such transactions can’t impact the P&L account.

Accounting conventions

Let us look at the accounting convention relating to treasury stock. As per international practice, buybacks can create treasury stock. However, under the buyback regulations of India, companies are not allowed to create treasury stock through buyback.

So, let us look at the international accounting standard governing the treatment of profit or loss from the trading of treasury stock. As per IAS 32, treasury stock held on the balance-sheet date has to be deducted from the share capital. Any profit/loss on sale of treasury stock during the period has to be adjusted to reserves and cannot be reflected in the P&L account. In this context, it may be noted that RIL in the consolidated accounts for 2007-08 has not deducted the treasury stock held by Petroleum Trust but has given a note on this.

From the above, logically and also as per the accounting conventions, the profit from the sale of these shares will not form part of profit for the year. But there is no doubt that shareholders could stand to benefit from the use of the cash generated from the sale.