August 31, 2011

China's pork processor Yurun Foods Group has generated about 9% of its profits from negative goodwill for the past five years, an accounting quirk that allows the company to mark up the value of the pig slaughterhouses it buys, raising a red flag for investors.

The Hong Kong-listed company with a market capitalisation of about US$4.2 billion, has bought eight slaughterhouses at knock-down prices since 2006 and booked HKD587 million (US$75.3 million) in gains.

To generate profits this way from negative goodwill several years running and across multiple transactions is highly unusual, said Gary Biddle, chairman of accounting at the University of Hong Kong.

Negative goodwill is rare because sellers do not usually part with their assets at bargain prices. The other concern is it is the buyer who determines how much it underpaid for the assets and what they are worth now.

The company and its auditors KPMG declined to comment.

Yurun is one of a number of Chinese businesses under fire from short sellers targeting alleged accounting problems. The company's shares have already lost a third of their value since mid-June, and several areas in the firm's accounts that are under scrutiny from investors.

Another area of concern is the high levels of government subsidies, which are above industry norms, and margins that appear out of whack with those of its peers.

None of this is conclusive, analysts said, adding that in the midst of a run of negative sentiment, Yurun's management has to work on generating positive investor goodwill.