Mafia Buzz Issue 3

Accountancy SA

Mike van Wyk takes a critical look at what can be in store for the profession if the Accountancy Professions’ Act incorporates some of the draconian conditions in the SOX Act. He makes a plea to you to get involved in commenting on the bill but holds out little hope that your submissions will be taken into account. (This is par for the course in our profession! Just look at how 3 500 submissions were ignored in the differential accounting document that was recently published by SAICA.) (Page 2)

Mike Savage says that only one third of staff of companies feel that the use of company hardware or software or the Internet amounts to fraud. (Page 6)

Wilna Steyn and Pieter von Wielligh ask the question: “Can we rely on cash flow statements?” They answer their own question by giving evidence that cash flow statements cannot be relied on. (From my personal experience, very few accountants understand the cash flow statement and, to be quite brutal, neither do the users of the financial statements. The old source and application of funds statement was easy to prepare and far more effective as a user document.) (Page 16)

Beric Croome says that the RSC and SETAs do not have the right to access of the books of companies. (Why even raise the issue? What have you got to hide? I would not object to them checking my books because I pay my levies in full each month. My only problem would be the time wasted.) (Page 19)

My article was about trying to get a ruling on a matter from the standard setters – do not bother to try! (Page 27)

Penelope Webb relates some interesting stories on tax fraud in her article. (Page 31)

Business Day

The auditing profession is dead against the rotation of audit firms. (One must agree that to rotate auditors for the sake of rotating is really dumb.) (6^th)

CFA Digest

The three steps to developing, implementing and maintaining an appropriate portfolio are:

1. 
   Asset allocation (deliver the right exposures and level of risk).
   
2. 
   Purchasing and maintaining reasonably priced representative securities.
   
3. 
   Verification that the agreed-upon strategy and return are being achieved.
   

(Instead of focusing only on risks at the allocation stage, should also focus on return.) (Vol. 33, No. 2, page 54)

Myron Scholes says that shares are not unique works of art but abstract rights to an uncertain income stream. (Investors forgot this simple concept during the IT boom.) (Vol. 33, No. 2, page 54)

There is empirical evidence that investments in mutual funds were eight times higher after a bull market than after a bear market. (Greed and emotion govern decisions.) (Vol. 33, No. 2, page 69)

Investor’s tax-sheltered assets are typically valued before deducting taxes. If these assets are to be converted into future retirement income, after-tax values are more appropriate. (Don’t invest in retirement annuities just because they are tax-free: you pay the piper at the end of the day!) (Vol. 33, No. 2, page 81)

Not re-balancing portfolios because of the tax implications could result in sub-optimal portfolio performance. (Vol. 33, No. 2, page 86)

CFA Magazine

During the 1990s, only 2% of recommendations made by sell-side analysts were to sell the stocks due to pressure put on them by the issuers of the stock. (January, page 5)

Some investment advice from the investment gurus:

1. 
   Making wealth is not the answer to human progress or happiness. Spiritual progress is the answer. (John Templeton) (An investment or spiritual guru?)
   
2. 
   The unthinkable can always happen and you have to run your affairs accordingly. Survival in this game begins with humility. (Peter Bernstein)
   
3. 
   Look at every stock as part of a business rather than things that go up and down. Have the right attitude to fluctuations. Build a margin of safety into what you pay. Prosper from the actions of the business rather than from the actions of the stock over the short term. The Investment Professionals Industry is the only industry I know where the professional’s efforts subtract value from what the layman can do himself. (Don’t you just love this man?) (Warren Buffett)
   
4. 
   Focus on long term investment and not on short-term speculation. Base the assessment on a steady, sophisticated enlightened, analytical approach rather than on the public appraisal of the price of the share.(Jack Bogle)
   
5. 
   Develop your skill set, work at it, hone it and do not follow the crowd. (Gary Brinson)
   
6. 
   Develop and stick to your own style. (Dean LeBaron) (January, page 20)
   

The most common financial shenanigans according to “How to Detect Accounting Gimmicks and Fraud in Financial Reports” are:

1. 
   Recording revenue too soon.
   
2. 
   Recording bogus revenue.
   
3. 
   Boosting income with one-time gains.
   
4. 
   Shifting current expenses to a later or earlier period.
   
5. 
   Failing to disclose all liabilities.
   
6. 
   Shifting current income to a later period.
   
7. 
   Shifting future expenses into the current period.
   

(They should come over to RSA – we can show them a thing or two!) (January, page 45)

To provide clients with accurate, high-quality, independent research, investment analysts must be free of undue influence. Here is what goes on:

1. 
   After analysts lower their view of stock, companies ignored these analysts during conference calls.
   
2. 
   Companies put pressure on analysts through their bosses.
   
3. 
   Some companies threaten analysts with court action if their stocks are downgraded. (March, page 2)
   

The SOX Act bans the following non-audit services by the external auditor:

1. 
   Bookkeeping services.
   
2. 
   Financial system design and implementation.
   
3. 
   Valuation of assets and liabilities.
   
4. 
   Actuarial services.
   
5. 
   Internal audit.
   
6. 
   Management services.
   
7. 
   Brokering, investment advising and investment banking.
   
8. 
   Most legal services.
   
9. 
   Expert opinions that support interests in litigation or administrative proceedings.
   

Auditors can still give tax advice. (March page 18)

Under pressure to meet earnings targets, maintain market capitalisation or retain access to financial markets, companies often resorted to non-GAAP financial measures. A popular one was called “pro-forma earnings” or “earnings before the bad stuff” such as depreciation, amortisation, asset write-downs, restructuring charges, etc. The SOX Act now requires disclosure of a reconciliation between these measures and the GAAP numbers. (March, page 24)

The Financial Accounting Policy Committee believes that in the setting of accounting standards a balance must be struck between broad principles and the inclusion of sufficient interpretation and implementation guidance (rules), which is necessary to ensure that the intent and spirit of the principles are clear. (Agree!) (March, page 24)

The Indiana University found that the following ratios showed promise in revealing the possibility of cooked books:

1. 
   Sales growth.
   
2. 
   Gross margin.
   
3. 
   General and administration expenses to sales.
   
4. 
   Debt to equity.
   
5. 
   Level of receivables.
   
6. 
   Level of inventories.
   
7. 
   Depreciation to cost of assets.
   
8. 
   Total accruals to total assets. (March, page 32)
   

Wall Street firms don’t make money by selling research – they make it in investment banking. So one can foresee more independent research firms getting a slice of this business in the future. (March, page 35)

We do not engage in the typical quantitative research of running thousands of back tests and, if you see a relationship, that’s the model. That approach is likely to fail in the real world. We try to make certain that our models all derive from fundamental casual investment relationships. (March, page 39)

The IASB is working on proposals together with the UK standard setting body, the ASB, to capitalise leases. David Tweedie says: “Wait for the squeals when it (the exposure draft) comes out.” (March, 2003)