AirAsia likely to equity account associates’ profits in 2013

PETALING JAYA: Low-cost carrier AirAsia Bhd will only start equity accounting its share of profits from Thai AirAsia (TAA) and Indonesia AirAsia (IAA) when the amount of unrecognised losses from these associates have been reversed, the airline told StarBiz. Some analysts say that can take place as soon as the year after next.

“It really depends on the level of profitability by the associates but a more comfortable projection would be for financial year 2013. If they make big profits next year and are able to reverse AirAsia's negative equity on both associates, then it could be sooner,” said a foreign research aviation analyst.

Analysts added that another consideration would be the impending listings of TAA and IAA, which would see an equity injection and allow them to re-capitalise. This could expedite AirAsia's equity accounting.

AirAsia told StarBiz that it would only start to equity account when the amount of unrecognised losses from TAA and IAA had been reversed. As of Dec 31, 2010, TAA's unrecognised share of net loss is RM127.8mil and IAA's unrecognised share of net loss is RM196.6mil (based on AirAsia's first quarter results announcement) for a total of RM324.4mil.

TAA achieved a net profit of RM283.10mil in 2010, compared with a net loss of RM80.42mil in 2009 while IAA also recorded a net profit of RM165mil last year against a loss of RM65.77mil in 2009.

Meanwhile, AirAsia Bhd posted a net profit of RM171.9mil, TAA made a net profit of RM80.72mil and IAA recorded a net profit of RM11.1mil for the quarter ended March 31, 2011.

OSK Research said in a report after AirAsia's first quarter announcement that it expects AirAsia to start equity accounting the earnings of TAA and IAA by financial year 2012, in line with management's earlier guidance, with TAA likely to start contributing as early as the fourth quarter of financial year 2011.

The research house has also started to equity account AirAsia's associate earnings for valuation purposes. AirAsia has investments of 48.9% in both TAA and IAA, with aviation laws in both Thailand and Indonesia requiring foreign shareholdings to not exceed 50% interest in these entities.

Based on the shareholders' agreements for these entities, TAA is a jointly controlled entity and IAA is an AirAsia associate.

AirAsia had previously drawn criticism from many parties as to why it never equity accounted the losses suffered by its associates and there were calls for greater transparency over the financial numbers recorded by the associates. The airline subsequently explained that with AirAsia having written down to zero its investments for both TAA and IAA in AirAsia's balance sheet, it did not need to recognise any further losses made by TAA and IAA as it had no accounting obligation to make good on those losses.

The equity method is an accounting method whereby the investment is initially recognised at cost and adjusted thereafter for the post-acquisition change in the investor's share of net assets of the investee. The profit or loss of the investor includes the investor's share of the profit or loss of the investee.

Another foreign research analyst said AirAsia had roped in its auditor PricewaterhouseCoopers Malaysia during a previous analysts briefing to explain why equity accounting for the associates was not done.

Market observers have also raised the question as to why AirAsia should reduce its interests in TAA and IAA to zero so that the losses by the associates are not reflected in its books, but then once the unrecognised losses are reversed, it can start equity accounting again.

“The airline is allowed to do so due to accounting regulations. Right now, AirAsia's investment has turned into negative equity and reducing its interests to zero means that it does not have to put in any more money,” says an analyst.

With AirAsia's share of losses for both TAA and IAA exceeding the cost of investment in these entities, AirAsia has in prior years fully provided for the investments in both associates (RM12mil for TAA and RM4mil for IAA), and discontinued recognition of share of any further losses as it has not provided any legal or constructive obligations or made payments on behalf of the associates.

Below are the answers provided by AirAsia Bhd in response to queries by StarBiz:

Q: Based on Malaysian accounting standards, the group's interest in TAA and IAA have been reduced to zero and the group will only resume recognising its share of profits only after its share of profits equal the share of losses not recognised? What does this mean and why was this done?

A: Under the abovementioned standards investments in joint ventures and associates are accounted for using the “equity method”.

This means that the investing company, i.e. AirAsia, shows its net share of the equity of the investee company on its balance sheet and recognises its share of the profits or losses of the investee company in its income statement. If the investee company makes losses and the investment on the investor's balance sheet is written down to zero, then the investing company should not recognise any further losses as it has no obligation to make good those losses. This is the principle of limited liability.

What was the amount in deferred tax assets written-off from the associates? Will there be further write-offs?

There is no deferred tax relating to associate or joint-venture companies and there have not been any “write-offs” relating to the same.

The associates provide lease rental income and maintenance charges for the group. Are there any other receivables from the associates? How is it that there is a separation when it comes to equity accounting while the group can still recognise rental income from its associates?

The recognition of lease rental income and maintenance reserves from TAA and IAA relates to the leasing of aircraft to those entities by AirAsia and is entirely distinct from the “equity accounting” described above. There are no other charges of a material nature. (For the quarter ended March 31, lease rental income on aircraft from TAA and IAA were RM64.74mil and RM54.24mil respectively)