Er-Kang Pharmaceutical Swallows Bitter Pill After Overstating Profit

Shares of a fast-growing Chinese pharmaceutical company opened down by the daily limit of 10% on Thursday, after the Shenzhen-listed firm said its 2016 net profit was overstated by 29% due to “serious accounting errors.”

Hunan Er-Kang Pharmaceutical Co. Ltd. said in a statement Wednesday that its net profit last year was 231 million yuan ($35 million) less than the previously reported figure. On Feb. 27, the company said its net profit in 2016 was 1.03 billion yuan.

The statement was the result of a six-month internal audit following media reports in May that alleged the company had falsified numbers. Since then, Er-Kang has suspended its shares from trading while conducting an internal investigation.

After a hiatus of almost six months, Er-Kang’s shares resumed trading on Thursday and opened down 10% at 10.31 yuan, the lowest in two years. Any listed company in China whose shares rise or fall by 10% automatically stops trading.

In the Wednesday statement, Er-Kang said the “accounting errors” were due to “a lack of communication between departments and subsidiaries.”

The company said it procured capsule starch from a subsidiary in Cambodia, to be reprocessed into capsules for final sale, and therefore booked such future sales as revenue of the parent company. However, as market conditions changed, some of the capsule starch was not used, and accountants did not subtract that part of projected sales in the profit-and-loss account to reflect that. This mistake contributed 208 million yuan of the 231 million yuan of overstated profit, the company said.

Er-Kang said it would enhance communication between the parent and subsidiaries, improve financial management and internal risk control capabilities.

The China Securities Regulatory Commission is still investigating the case and will later give a more accurate report, Er-Kang said.

Er-Kang, a mid-sized firm whose market value ranks only the 33rd among all listed drug-makers in China, has impressed the industry with a 50% annual profit growth between 2010 and 2016.

Contact reporter Coco Feng (renkefeng@caixin.com)