Professional Documents
Culture Documents
To order copies, call +91-08417-236667/68 or write to IBS Center for Management Research (ICMR), IFHE Campus, Donthanapally,
Sankarapally Road, Hyderabad 501 504, Andhra Pradesh, India or email: info@icmrindia.org
www.icmrindia.org
Introduction
Infosys Technologies (Infosys), one of India’s best-known computer software companies, provided
consulting and IT services to clients globally. With over 19,000 employees worldwide, Infosys
was the second largest exporter of software from India, after Tata Consultancy Services (TCS).
Based in Bangalore, India's "Silicon City", Infosys offered a range of customized software services
including development, maintenance, reengineering, and consulting. The company had also set up
several dedicated offshore software development centers for large clients. Infosys was widely
considered to be one of India’s most respected and admired companies. The company was well
known for its excellent governance and financial reporting practices.
Infosys had been one of the first companies in India to issue stock options (ESOP) to its
employees. In recent times, accounting for stock options had become a controversial subject in the
US. With its ADRs listed on the NASDAQ, Infosys was not insulated from the debate in the US.
By 2003, the debate on expensing stock options in the income statements had become intense.
Analysts speculated that the main regulatory body in the US, Securities and Exchange Commission
(SEC) might make it mandatory for tech companies to expense stock options. In India, the
Securities & Exchange Board of India (SEBI) had also issued accounting guidelines for stock
options.
Exhibit: I
Infosys: Corporate Profile
1
The Hindu Business Line, 11th July 2003.
Background Note
After receiving a master’s degree in electrical engineering from one of India's highly regarded
Institutes of Technology (IIT - Kanpur) in the 1960s, Narayana Murthy (Murthy) left for France to
develop software for the air traffic control system at Paris' Charles de Gaulle airport.
During college, Murthy had believed that communism was the answer to his country's problems of
poverty and corruption. This belief was strengthened during his time spent with Paris leftists in the
1970s. But while hitchhiking back to India in 1974, Murthy's Marxist sympathies eroded quickly
after he was jailed in Hungary for allegedly disclosing state secrets while talking with Austrian
tourists on a train. The event triggered Murthy’s entrepreneurial move. In 1981, Murthy convinced
six fellow software engineers to join him. Infosys was founded that year with $250 in capital
(mostly borrowed from their wives).
From the beginning, Infosys looked for business outside India. But a lack of reputation and
government regulations made things difficult for Infosys during the 1980s. It took nine months just
to get the company's first telephone line, and three years to import new computers. The company
slowly expanded and opened its first US office in 1987.
Many of the government regulations that had kept India's economy stagnant were lifted when
economic reforms swept the country in 1991. Infosys began earnest efforts to capitalize on the new
opportunities which had opened up.
Exhibit: II
Infosys: Key milestones
Year of Incorporation: 1981
Became a public limited company in India: 1992
ISO 9001/TickIT Certification: 1993
Attained SEI-CMM Level 4: 1997
Listed on NASDAQ: 1999
Crossed $100 million in annual revenues: 1999
Attained SEI-CMM Level 5: 1999
Crossed $400 million in revenues: 2001
Crossed $ half a billion in revenues: 2002
Source: www.infy.com
In 1995, Infosys lost its biggest customer, General Electric, which accounted for more than 20% of
sales. Infosys decided it would not let one client or product drive more than 10% of its business.
The company diversified its customer base by finalizing deals with Xerox, Levi Strauss, and
Nynex.
Infosys grew so rapidly in the mid-1990s by signing short-term pilot projects that it was able to
move into more extensive contracts for managing mainframe upgrades, designing custom
software, and implementing e-commerce systems.
In 1998, Infosys established offices in Canada, Japan, and the US to strengthen its marketing
efforts. In 1999, Infosys became the first Indian company to list its shares on NASDAQ, an
offering timed perfectly to capitalize on the surge in demand for technology stocks. Infosys'
market cap ballooned to more than $17 billion in 2000.
Infosys got into a long-term pact with Microsoft to dedicate more than 1,200 engineers to build e-
commerce, financial services, and customer relationship management applications for the software
giant in 2000. In 2002, Murthy stepped down from the day-to-day management of the company.
The much younger co-founder Nandan Nilekani (Nilekani) took over as CEO. Murthy, who
remained chairman, adopted the new title, chief mentor.
In 2003, Infosys had offices in Argentina, Australia, Belgium, Canada, China, France, Germany,
Hong Kong, India, Japan, Mauritius, Sweden, the United Arab Emirates, the UK, and the US. Its
ambitions of becoming a global player in the software industry seemed to be stronger than ever. In
this context, the ability to attract and retain good people, using stock options, remained a key
concern for the top management.
Exhibit: III
Infosys: Summary Financials
For the financial year ending March 31, 2003
US GAAP
Revenues: $ 753.8 million
Net Income after taxes: $ 194.9 million
Earnings per ADS: $ 1.47 (diluted)
Total assets: $ 704.3 million
Cash and cash equivalents: $ 354.3 million
Indian GAAP
Total Income: Rs. 3,622.69 crore
Net profit after taxes: Rs. 957.93 crore
Earning per share (Rs. 5): Rs. 143.37 (diluted)
Total assets: Rs. 2,860.65 crore
Cash and cash equivalents: Rs. 1,638.51 crore
Source: www.infy.com
2
A hybrid type of contractual agreement that deals with both the aspects of cost reimbursable contract and
fixed price contract. A cost reimbursable contract involves payment to the seller for its actual costs (direct
and indirect costs), plus a fee representing a seller’s profit. In a fixed price contract, the amount to be paid
is fixed for a specified amount of work or specified deliverables. The performing contractor is legally
obligated to finish the job, no matter how much it costs to complete. T&M contracts resemble cost-type
arrangements in that they are open-ended. The full value of the arrangement is not defined at the time of
award and thus can grow in contract value as if they are cost-reimbursable type. Alternatively, they may
also resemble fixed-type arrangements, say, when the unit rates are preset by the buyer and the seller as
and when both parties agree on the rates for the resources/material.
Interest was recognized using the time-proportion method, based on rates implicit in the
transaction. Interest accrued was determined by the amount outstanding and the rate applicable.
Usually, discount or premium on debt securities held was treated as though it were accruing over
the period to maturity.
Expenditure
The cost of software purchased for use in software development was charged to cost of revenues in
the year of acquisition. Charges relating to non-cancelable, long-term operating leases were
computed on the basis of the lease rentals, payable as per the relevant lease agreements. Provisions
were made for all known losses and liabilities. Provisions for any estimated losses on incomplete
contracts were recorded in the period in which such losses became probable, based on current
contract estimates.
Exhibit: IV
Infosys: Expenditure
In Crores Rs.
Year ended March 31 2003 2002
Income from software services and products 3,622.69 2,603.59
Software development expenses 1,813.30 1,224.82
Gross profit 1,809.39 1,378.77
Selling and marketing expenses 266.98 129.79
General and administration expenses 270.37 211.35
Total operating expenses 2,350.65 1,565.96
Operating profit 1,272.04 1,037.63
Interest - -
Depreciation 188.95 160.65
Operating profit after interest and depreciation 1,083.09 876.98
Other income 99.61 66.41
Provision for investments 23.77 -
Profit before tax and extraordinary item 1,158.93 943.39
Provision for tax 201 135.43
Net profit after tax 957.93 807.96
Source: Annual Report 2003.
Intangible assets were amortized over their estimated useful lives on a straight-line basis,
commencing from the date the asset was available to the company for its use.
Exhibit: V
Infosys: Fixed Assets and Depreciation & amortization
In Crores Rs. Depreciation and Net book
Original cost value
amortization
Exhibit: VI
Infosys: Estimated Useful Lives of Various Fixed Assets
Building 15 years
Plant and Machinery 5 years
Computer equipment 2-5 years
Furniture and fixtures 5 years
Vehicles 5 years
Intellectual Property Rights 1-5 years
Source: Annual Report 2003.
Gratuity
Infosys provided a defined benefit3 retirement plan (the Gratuity Plan) covering eligible
employees, in accordance with the Payment of Gratuity Act, 1972. Alternatively, a trust fund could
be created, or an arrangement could be negotiated with an insurer so that the annual contributions,
calculated actuarially, could be made each year. Benefits to employees on entitlement would in
such a case be paid by the trust fund or by the insurer.
The employees, who had rendered continuous service for at least five years, were eligible for 15
days pay for each completed year of service. The gratuity benefit was payable on termination of
employment (either by resignation, death, retirement or termination etc), by taking the last drawn
basic salary as the basis for the calculation.
3
Retirement benefit plans under which amounts to be paid as retirement benefits are determinable usually
by reference to employee’s earnings and/or years of service.
Liabilities with regard to the Gratuity Plan were determined by actuarial valuation4, based on
which, the company fully contributed all the ascertained liabilities to the Infosys Technologies
Limited Employees’ Gratuity Fund Trust (the Trust). Trustees administered the contributions made
to the Trust and invested in specific designated securities (as mandated by law), which generally
comprised central and state government bonds and debt instruments of government-owned
corporations.
Superannuation
Some Infosys employees were also participants of a defined contribution plan5. Here, the employer
typically made a contribution once a year towards a separately created trust fund or to a plan
administered by an insurer. These contributions earned interest and the accumulated balance of
contributions and interest were used to pay the retirement benefit to the employee.
Superannuation available under a defined contribution plan was relevant only to the total of
accumulated contributions and interest and bore no relationship, with the final salary or number of
years of service put in by an employee. The defined contribution plan for superannuation/pension
was, in most respects, similar to the provident fund, so far as the accounting treatment was
concerned. It also presupposed payment of contributions every year, either once in a year or more
frequently. The company made monthly contributions under the superannuation plan (the Plan) to
the Infosys Technologies Limited Employees Superannuation Fund Trust based on a specified
percentage of each covered employee’s salary. The company had no further obligations to the Plan
beyond its monthly contributions.
Provident Fund
Infosys contributed a part of the contributions to the Infosys Technologies Limited Employees’
Provident Fund Trust. Eligible employees received benefits from a provident fund, which was a
defined contribution plan. Both the employee and the company made monthly contributions to the
provident fund plan equal to a specified percentage of the covered employee’s salary.
Provident fund benefit normally involved either the creation of a separate trust to which
contributions of both employees and employer were made periodically or remittance of such
contributions to the employees’ provident fund, administered by the Central Government. The
remaining contributions were made to a Government administered provident fund. The company
had no further obligations under the provident fund plan beyond its monthly contributions.
Provident fund plans, were generally contributory schemes from the point of view of employees.
Gratuity plans were non-contributory while superannuation plans, could be contributory or non-
contributory.
4
Process used by an actuary to estimate the present value of benefits to be paid under a retirement benefit
plan and the present values of the plan assets and, sometimes, of future contributions.
5
Plans under which amounts to be paid as retirement benefits are determined by contributions to a fund
together with earnings.
The exchange differences arising on foreign currency transactions were recognized as income or
expense in the period in which they arose. Fixed assets purchased in overseas offices were
recorded at cost, based on the exchange rate as on the date of purchase. The charge for
depreciation was determined as per the company’s accounting policy. Monetary current assets and
current liabilities that were denominated in foreign currency were translated at the exchange rate
prevalent on the date of the balance sheet. The resulting difference was also recorded in the profit
and loss account. In the case of forward contracts, the difference between the forward rate and the
exchange rate on the date of the transaction was recognized as income or expense over the life of
the contract.
Income Tax
Infosys followed Accounting Standard 22, for computed Income taxes using the tax effect
accounting method. Taxes were accrued in the same period, the related revenue and expenses
arose. A provision was made for income tax annually based on the tax liability computed, after
considering tax allowances and exemptions. Provisions were recorded when it was estimated that a
liability due to disallowances or other matters was probable. The differences that resulted between
the profit offered for income taxes and the profit as per the financial statements were identified,
and subsequently a deferred tax was recorded.
Exhibit: VII
Infosys: Income Tax
In Crores Rs.
Income Taxes Paid during the Year 2003 2002
Charge as per the Profit and Loss Account 201 135.43
Add: Increase in advance income taxes 53.74 112.51
Less: Increase / (Decrease) in income tax provision (35.24) (116.67)
219.5 131.27
Source: Annual Report 2003.
Deferred taxation was the tax attributable to timing differences6 or a liability that resulted from
income already earned and recognized for accounting purposes, but not for tax purposes, that was
recorded on the balance sheet. Deferred tax assets7 and liabilities8 were recognized for all timing
differences subject to consideration of prudence in respect of deferred tax assets. The tax effect
was calculated on the accumulated timing differences at the end of an accounting period based on
the prevailing enacted or substantially enacted regulations. The accumulated deferred tax liability
at the beginning of the year was recognized with a corresponding charge to the general reserve, in
the year of transition. Deferred tax assets were recognized only if there was reasonable certainty
that they would be realized and were reviewed for the correctness of their respective carrying
values on each balance sheet date.
Investments
Investments were either classified as current or long-term based on the management’s intention at
the time of purchase. Current investment by nature was readily realisable and was intended to be
held for not more than one year. Current investments were carried at the lower of cost and fair
value. Cost for overseas investments comprised the Indian Rupee value of the consideration paid
for the investment.
6
Differences between profits or losses as computed for tax purposes and results as stated in financial
statements, which arise from the inclusion of items of income and expenditure in tax computation in
periods different from those in which they are dealt within the financial statements.
7
Deferred tax assets are prepaid income taxes and meet the definition of assets.
8
Amounts of income taxes payable in future periods in respect of taxable temporary differences.
Long-term investments were carried at cost and provisions recorded to recognize any decline,
other than temporary, in the carrying value of each investment. Any dividends were recorded as
income in the profit and loss account.
During the year ended 31st March 2003, Infosys invested Rs. 0.27 crores in M-Commerce Ventures
Pte Limited, Singapore (“M-Commerce”) for 10 ordinary shares of face value Singapore $ (“S$”)
1 each, fully paid at par and 90 redeemable preference shares of face value S$ 1 each, fully paid
for a premium of S$ 1,110. Accordingly, the aggregate investment in M-Commerce as on 31st
March 2003, amounted to Rs. 2.11 crores. Current liabilities included an amount of Rs. 2.94 crores
received from Workadia Inc., towards recovery of investment that was pending clearance from
regulatory authorities for setting off against the investment.
Under the ESOP scheme, the warrant holders were entitled to convert the warrants before any
bonus or rights issue. Infosys had issued bonus shares in the ratio of 1:1 during October 1997 and
March 1999. The warrant holders, including the Trust and the employees, were given an option to
convert their warrants, and all warrants were converted into shares.
Infosys effected a stock-split (i.e. a subdivision of every equity share of par value of Rs. 10 each
into two equity shares of par value of Rs. 5 each) in February 2000. By January 2003, the lock-in
period ended in respect of 4,45,000 shares of par value of Rs. 5 each, held by 312 employees for
warrants issued in January 1998. Employees held 7,12,000 shares of par value of Rs. 5 each
subject to lock-in and 3,18,200 rights to shares of par value of Rs. 5 each, as on 31 st March 2003.
957 employees held shares under the 1994 Stock Option Plan. As on 31st March 2003, 504
employees held rights to 3,18,200 shares of par value of Rs. 5 each, which were subject to a lock-
in of 1-2 years. In the event of an employee leaving Infosys before the vesting period10, the shares
under lock-in were transferred to the Infosys Technologies Ltd. (ITL) Employees Welfare Trust.
As on 31st March 2003, the ITL Employees Welfare Trust held 3,42,000 shares of par value of Rs.
5 each.
9
A security entitling the holder to buy a proportionate amount of stock at some specified future date at a
specified price, usually one higher than current market. This "warrant" is then traded as a security, the
price of which reflects the value of the underlying stock.
10
The period of time before an option cannot be exercised.
Exhibit: VIII
Infosys: Stock Options under 1998 Plan
Exhibit: IX
Infosys: Stock Options under 1999 Plan
Infosys’ BPO subsidiary Progeon’s11 2002 Plan provided for the grant of stock options to
employees of the company and was approved by the board of directors and stockholders in June
2002. All options under the 2002 plan were exercisable for equity shares. The 2002 plan was
administered by a Compensation committee comprising three members, all of whom were
directors of Progeon. The plan provided for the issue of 52,50,000 equity shares to employees, at
an exercise price, which was not less than the fair market value. The options issued under the 2002
plan vested in periods ranging between four to seven years. All options granted, were accounted
for as a fixed plan.
Employee Stock Option Plan under SEBI guidelines
The Securities and Exchange Board of India (SEBI) had earlier issued the (Employee Stock Option
Scheme and Employee Stock Purchase Scheme) Guidelines, 1999, which was effective for all
stock option schemes established after 19th June 1999. In accordance with these guidelines, the
excess of the market price of the underlying equity shares as of the date of the grant of the option
over the exercise price of the option was to be recognized and amortized on a straight line basis
over the vesting period. The company’s 1994 stock option plan was established prior to SEBI
guidelines on stock options. All options under the 1998 and 1999 stock option plans were issued at
fair market value. Hence there were no compensation costs.
11
Infosys established Progeon Limited as a majority owned and controlled subsidiary on April 2002, to
provide business process management and transaction services.
Exhibit: X
Infosys: Stock Option Expensing under SEBI guidelines
Exhibit: XI
Infosys: Stock Option Expensing Under US GAAP
Bibliography
1. Stephen Bernhut, “Interview: N.R. Narayana Murthy, CEO, Infosys Technologies,” Ivey
Business Journal, September /October 2001, Vol. 66, Issue 1, p-52.
2. “Infosys Technologies Announces 24% Rise in Net Profits,” Emerging Markets Economy,
10th January 2002.
3. Sudhakar Kosaraju, Siliconindia, “BPO: Will It Yield the Next Infosys?” September 2002,
Vol. 6 Issue 9, p-44.
4. “The SAND Infosys Increases Full-Year Guidance After Q3 Revenue Surge,”
Computergram Weekly, 13th January 2003, Issue 4582, p-5.
5. K. Giriprakash “SEC mulls `expensing stock options' mandatory — Infy, Wipro bottomline
may take a hit,” Business Line, 5th February 2003.
6. “Compendium of Accounting Standards,” The Institute of Chartered Accounts of India, 1st
July 2003.
7. CMIE: Prowess Database.
8. CMIE: Industry Analysis Service.
9. Infosys Annual Reports, 2003.
10. www.infosys.com.
11. www.investopedia.com.
12. www.hoovers.com.