An Accounting Shocker at Israel Electric Corporation

Some 40% of the utility’s wage costs were listed as capital spending on fixed assets.

Two weeks ago I wrote an article in which I described the difference between taking small, symbolic actions that have no significant consequences, and the implementation of large moves that have substantial effects. The argument was that because attention often focuses on symbols, it is easy to confuse token steps with meaningful ones.

One example was the salaries paid by the Israel Electric Corporation, which have been the subject of much attention and criticism lately. But in fact, these outlays have little impact on our electricity bills, the issue that really interests us. To highlight this issue, I analyzed the IEC's expenditures on salaries in relation to those spent on fuel purchases.

Luckily, due to the diligence of TheMarker's editors, I was caught out in what could have been an embarrassing mistake. The numbers I was using for IEC salaries were gross underestimates. I was surprised to find this out, since I hadn't made these numbers up. I had used reports of profits and losses published by the IEC itself. How could there be such a significant gap between real salary figures and what the corporation publishes in its reports? This required further digging.

In contrast to supernatural effects that have no scientific explanation, odd financial figures usually have a concrete rationale. This was indeed located, buried in the attachments to the financial reports. It turned out that 40% of salary expenses at the IEC are reported as capital expenditure on fixed assets. These outlays are registered as construction of power production or transmission facilities. Salaries are registered as assets that are amortized over time, not appearing as current expenses. This can hardly be termed "conservative" accounting practice.

Thus, for 2011, the latest year for which full reports are available, the IEC reported NIS 4.4 billion as salaries. However, NIS 1.7 billion of these were registered as investment in fixed assets and were not reported as expenses. This gap of 40% between reported and real salaries is not atypical, and has been common practice for years.

Crafty accountants

I don't wish to accuse the IEC of falsifying its reports. Crafty accountants might find ways of rationalizing these disparities. However, one conclusion is justified. Bondholders and banks looking at the IEC's financial reports usually examine operational profits or the corporation's earnings before interest, taxes, depreciation and amortization (EBITDA ). In light of the IEC's accounting practices, creditors need to deduct large amounts of capitalized salary expenses from the reported salary figures. This is due to the fact that the corporation incurs large cash outlays that are not reported in the books for the relevant fiscal year. In the IEC board of directors' reporting of the corporation's activities, it is stated that 2,000 employees, just under one sixth of the total, are employed in infrastructure construction, considered an investment. Even if one accepts the calculation of their salaries as an investment, there is still a large gap between one sixth (16.7% ) of the employees involved and the 40% gap between salaries paid and investment expenses, as reported.

Some interim conclusions: I am often asked why I am cynical and skeptical when it comes to corporations and their directors. The mistake I made, which was easy to make, reminded me of the reason: experience. Mistakes can happen to anyone, and it often turns out that delving into errors turns up interesting and surprising new findings.

There is no dispute regarding the exorbitant salaries paid by the IEC, and the creative ways they are registered in their financial reporting. After correcting for these, is it still true that IEC salaries do not impact our bills? This requires a re-examination of the figures, avoiding the accounting trap.

Those figures show that the increase in fuel costs between 2009 and 2012 had a much greater impact on utility bills than did salaries. In 2009, 46% of the IEC's revenues went to fuel purchases, increasing to 54% by 2012, despite the large increase in utility bills paid by its customers. Expenses on salaries, which also went up sharply, still comprised only 16% of the corporation's revenues, a smaller proportion than in 2009.

Cutting wages

Analyzing these figures shows that even if salaries at the IEC were cut by a third, a daunting task without many prospects of happening, electricity bills would drop by only 5% (assuming the entire amount were passed on to consumers ). This is significant, but certainly not a dramatic shift, even without taking into account the anticipated reaction by IEC employees to such drastic cuts. In contrast, reducing fuel costs by one-third would result in savings of 18% for consumers. These are purely theoretical scenarios, designed only to highlight the initial claim. Even using the corrected salary figures don't alter the picture. The real cause of the spike in our power bills is the rise in the price of fuel. Reducing IEC salaries, exorbitant and outrageous as they may be, and their erroneous and misleading reporting notwithstanding, will not significantly affect utility bills. This analysis should not excuse government-owned company such as the IEC for wastage and paying such outrageous salaries. This is totally unjustifiable. However, despite the public's anger at the IEC and its employees, one should still look at the facts squarely and honestly, assuming they are reported correctly. Lower rates depend on lower fuel prices, and lower salaries will only make a small dent. Even the corrected figures clearly demonstrate these facts.

Eliyahu Hershkovitz