Mafia Buzz Issue 3

Techtalk

The first issue has been dealt with by SAICA on headline earnings. I will cover it in the GAAP update workshops. I disagree with the conclusions.

Revaluations of available-for-sale financial assets (defined as non-trading in AC133) were treated as capital items in the past in the calculation of headline earnings. They are now treated as trading items! (I really would love to know why. The fact that the JSE has not complained about this total destruction of the concept of headline earnings astounds me. Everyone seems to be fast asleep!)

Please note that I am not dealing with proposed changes to GAAP here for two reasons: 1. They could change their minds. 2. Nothing we say will change what they are doing. So it is a total waste of time to even look at these proposals at this stage. We will wait for the final statements to be published.

On page 21 they list the technical staff of SAICA. I think that they are taking affirmative action beyond the pale! There is not, on the technical staff, one male!

Commentary

The Citizen reported that our very own home grown Jack Milne has at last admitted that he was pouring investors’ money into the Tigon black hole (if you could not have foreseen this, you were out of touch with reality). It is amazing that people are quite happy to hand their hard-earned cash to an individual to invest for them. The simple fact is that people who take control of other peoples money cannot be trusted to act in the best interest of the investors. Rule 1 of investing is “Keep in control of your own wealth.”

Prior to the Enron scandal, Arthur Levitt, the former chairman of the US SEC said: “We are witnessing an erosion in the quality of earnings. Managing may be giving way to manipulation. Too many corporate managers, auditors and analysts are participants in a game of nods and winks. Wishful thinking may be winning the day over faithful representation.”

Happiness is being too shallow to realise how miserable you should be. It is cocooning oneself from reality. When displayed wantonly in public, it is the cause of other people’s unhappiness. Happiness is abnormal. (Time Magazine)

From SAICA’s Abridged Financial Statements:

Finance Week, March 2003

The top twenty companies in RSA based on market capitalisation were, in order, Anglo American, BHP Billiton, Richmont, Sasol, Angloplat, Anglogold, SAB, Goldfields, Old Mutual, Standard Bank, First Rand, Implats, Remgro, Nedcor, Sappi, Harmony, LibInt, Absa, MTM and Sanlam. Resources and financials dominate the top twenty.

AIMR Conference Proceedings

Management is giving way to manipulation. Too many corporate managers, auditors and analysts are participants in a game of nods and winks. Earnings reflect the desires of management rather than the underlying financial performance of the company. Too many analysts and portfolio managers take companies’ financial reports at face value.

From SAICA’s Financial Statements

The Financial Reporting Bill will establish a new standard setting body and will hopefully be enacted shortly. It will provide for monitoring compliance with accounting standards. It will address the legal backing issue and will introduce a process for developing accounting standards appropriate to small and medium enterprises. (What does “shortly” mean?)

It was agreed that the discounted rates for certain SAICA seminars would be withdrawn. Unfortunately, the seminars affected by the discounted rates suffered a drop in attendance of about 35% in 2002. (Two mistakes: 1. Never discount a superb product, as users will get suspicious of the quality. 2. Do not conclude that the fall in attendance was due to discounting – look for the real reasons! What I find amazing is that subsequent to this report SAICA announced that certain seminars would be priced at “huge” discounts!)

SAICA is looking into a new system of continuing professional development. This topic needs to be discussed in a straight talking article!

SAICA is investigating Leisurenet and Regal Treasury, which could cost upward of R2 million. SAICA looks upon this cost as an investment in the future because of its deterrent effect. “We have to do it and be seen to be doing it.” (I have a problem with the logic: Why should this effectively be costing the members? The firms that are being investigated should be incurring the cost. To have a “deterrent effect” the culprits should pay!)

Taxgram

The Minister of Finance and SARS are working on regulations to govern tax consultants. To be a tax advisor in future you will probably have to pass certain examinations, join SAITA (the South African Institute of Tax Advisors), be subject to practice review, etc. etc.

SAICA’s Communique

The guidance examples supporting AC133 can be got by going to: http://www.saica.co.za/Displaycontent.asp?theID=1181.

You can download the circular on headline earnings by going to http://www.saica.co.za/Displaycontent.asp?theID=1182.

July 2003 (30 Minutes)

Accountancy

The SEC has asked a judge to place a six-month ban on Ernst and Young to prevent them from acquiring new audit clients. (Page 6)

Deloitte and Touche were found to be negligent as auditor of Barings but the penalty was reduced due to the incompetence of Barings itself, i.e. there was an apportionment of blame. (Page 9)

The FRC has caved in to corporate pressure for the Higgs report (equivalent to our King report) to be less prescriptive. (It really is good to see democracy at work in the UK!) (Page 9)

The IASB has issued its first IFRS i.e. number 1, First time adoption of International Reporting Standards. (Page 12)

The proposal to account for share based payments could make companies abandon their share option schemes. This would be a pity as such schemes lead to enhanced productivity, increased returns on capital and better cohesion in the workplace. (This is not what I find.) The author says that the Black-Scholes model is inappropriate for valuing an option on a long-term basis. What should be accounted for is the effective interest free loan to the employee and not the value of the option. (Agreed.) (Page 14)

Deloitte Consulting has developed a software package to identify overblown corporate jargon such as “synergy”, “paradigm”, “extensible repository”, etc. It is called “Bullfighter” and can be downloaded from www.dc.com/bullfighter. (Page 16)

It has been estimated that the cost to British business of conversion to IFRS will be some ₤500 million. These costs will include staff training and recruiting, system changes, amending incentive schemes, briefings for boards and audit committees, etc. The benefits to be had are the savings in costs due to consistent and comparable financial statements across borders. This conversion process provides a lucrative opportunity for clever audit firms. On the downside, mistakes could be made, investors could get confused and companies could get spooked and start bending an unclear set of rules to meet expectations. This could result in more confidence busting corporate scandals. (Page 19)

Short-term thinking is losing out to long term strategy. (It is about time this was addressed!). (Page 20)

Here is a nice comparison for you:

‘000 1961 2002

British people getting married for the first time 350 180

British people getting remarried 50 120

British people getting divorced 30 150

Conclusion? There is money to be made in dating agencies! (Page 24)

Following the agreement by the US standard-setter to converge with IFRS, a short-term project has been set up to remove a variety of individual differences between US GAAP and IFRSs. (Page 81)

British companies are experiencing trauma at the thought of converting to IFRS. Here are some of the potential problems:

1. 
   The capitalisation of certain leases could have devastating effects on their debt to equity ratios.
   
2. 
   Having to recognise derivatives could have a negative effect on the amount of equity they report on the balance sheet.
   
3. 
   The above two problems could have serious repercussions regarding covenants in loan agreements and restrictions on borrowings in the articles of companies. (Page 90)
   

British accountants do not believe that converting to IFRS will improve their reporting standards (they are probably right). (Page 93)

There is a perception that the UK has too much influence on the IASB. It is based in London, chaired by a British accountant, staffed by UK accountants and five of the board members have British passports. (Page 93)

There is a fear that if IFRS is imposed on SMEs, there could be a backlash, as it is felt that the excessive cost for small companies will not result in any benefits. (Page 93)

IFRS 1, First-time adoption of international financial reporting standards requires disclosures to explain how the transition from previous GAAP to IFRSs affects the reported financial position, financial performance and cash flows (can an accounting policy affect cash flows?). Companies need to start planning “now” (already getting too late). They need to consider how the transition will affect investor relations, what the consequences will be for employee incentive schemes and how it will affect restrictions in contracts based on information in financial statements. (Page 95)

The IAASB has exposed proposals on quality control for audit, assurance and related services practices. Topics covered are leadership responsibilities, ethics, engagement performance, quality control review and monitoring. (Page 96)

The British government has instigated a study into reporting for human capital and measuring performance. The argument is “what is not measured is not properly valued and cannot be effectively managed”. Topics to be covered are:

1. 
   The size and composition of the workforce
   
2. 
   Employee motivation, staff turnover and absentee rates
   
3. 
   Staff training and development
   
4. 
   Remuneration and fair employment practices
   

(As long as they do not ask accountants to start valuing humans and recognise them on the balance sheet, I am happy with this idea.) (Page 97)

The brilliant and clear thinking Mr Ron Paterson addresses the problem with accounting for decommissioning costs. In the past these costs were charged to income over the life of the asset, with the credit going to a provision. This way a proper charge to income resulted – perfect matching subject to changes in estimates, which is a normal feature of accounting. However, “New-GAAP” requires the full liability to be raised. The problem was whether to take the full cost to income immediately. This would have had a massive impact on income so the debit went to the asset (a future cost is now an asset!). And then came the problem of discounting. As the liability was only going to be incurred in the distant future, it has to be discounted to the reporting date. The unwinding of the interest charge is then charged to income in the pattern of a hockey stick, resulting in over-reporting of profits in early years and taking the pain in later years. His conclusion is that the standard is built on shaky principles and any interpretations of it are likely to be unconvincing and anomalous. He says that when you are in a hole it is unwise to keep digging. (Page 99)

It is clear that there is a need for a strong relationship between internal and external auditors. The two types of audits have distinct roles:

1. 
   Internal audit is a control function helping management to ensure that effective processes are in place to manage risk.
   
2. 
   External audit provides assurance to shareholders and the board that the financial performance is fairly reported in the financial statements.
   

The audit committee is the best way to facilitate this relationship. (Page 100)