Mafia Buzz Issue 3

Accountancy SA

Linda de Beer sets out the plan for the new statements. By 2005, when the EU changes over, the IASB will have completed statements on first time application of GAAP, business combinations, share-based payments, insurance contracts and the statements issued under the improvements-project, which includes financial instruments. The IASB will address SMEs. The project will not be concluded in time for our local needs (the need arose ages ago!). She hints that equity accounting could be scrapped – a scary thought. Will they require us to fair value associates thereby making financial statements even more unreliable than they are at present? (Page 11)

Garth Coppin looks at how the Sarbanes-Oxley Act affects non-USA companies. He believes that this Act was a knee-jerk reaction by politicians and not an act of statesmanship. He also foresees that non-US companies listed in the US could move their listings to European exchanges. (Page 14)

Glen Mouton asks the question: “Are you at risk?” He says that the directors are responsible for identifying the controls that should be in place. He reminds us that most large frauds are perpetrated by the entity’s own staff. He lists theft and false accounting as the two biggies. (Page 17)

Debbie Scheepers discusses the components approach to accounting for property, plant and equipment. I think that she misinterpreted what the statement is trying to achieve. (Page 20)

My article was on whether one should treat a provision for environmental damage as debt or an operating liability when assessing a company’s value. I concluded that it should be treated as an operating liability and that the expense should be treated as an operating cost (after much effort). (Page 20)

Nigel Payne’s article was on compliance with the requirement in the King Report for the directors to maintain a sound system of risk management and internal control to provide reasonable assurance regarding the achievement of organisational objectives. His focus in the article is on IT governance and audit.

Business Day

Recent amendments to the JSE regulations require companies to include in their financial statements an explanation as to why they deviate from any of the principles in the King report. (7^th)

Philip Hourquebie of Ernst and Young says that rotation of audits is not the answer to the independence and quality of an audit. He believes that this approach causes more problems than it solves. He says that an auditor has to have a deep understanding of the business to enable an audit to be carried out effectively. This takes time and is costly. Rotation will result in higher costs and reduce the quality of the audit. (29^th)

Financial Mail

Consultancy firm Watson Wyatt says that global pension fund assets have shrunk by $2,7 trillion in the past three years to just under $11 trillion. (17^th, page 8)

President Bush is considering dropping tax on dividends in the US to make investments in equity more attractive to investors. (17^th, page 15)

ABSA’s Dividend Income Fund promises to deliver a high level of income primarily in the form of dividends. In reality, the fund, which has attracted R823 million, had a 100% cash content at the end of both the third and fourth quarters of 2002. For this the investors are paying 1,71% annual management fee. (31^st, page 51)

Finance Week

According to a Department of Trade and Industry spokesman changes to the Companies Act should be completed by 2005 (just in time to save SMEs from the burden of having to comply with IFRS statements!!!). (29^th, page 8)

More than 70% of pension fund portfolios recorded losses last year. (29^th, page 8)

An article encouraging you to invest overseas is called “Giving your money wings” – very appropriate, you will never see it again! (29^th, page 46)

Techtalk

The following exposure drafts have been issued:

1. 
   Share based payments (www.saica.co.za).
   
2. 
   Reporting on compliance with international financial reporting standards (www.paab.co.za).
   
3. 
   Audit risk (www.paab.co.za).
   

(2) above deals with, among other things, reporting when the financial statements purport to comply with both IFRS and local accounting standards. (3) is designed to improve the linkage between audit risk and audit procedures, thereby improving the quality of an audit.

The following new pronouncements have been made:

1. 
   Enquiries regarding litigation and claims (SAAS 502).
   
2. 
   Auditing fair value measurements and disclosures (SAAS 545).
   
3. 
   The relationship between banking supervisors and banks’ external auditors (SAAS 1004).
   
4. 
   Audits of the financial statements of banks (SAAS 1006).
   

The following new circulars have been issued:

1. 
   Subordination agreements (2/2002).
   
2. 
   Letters of support (3/2002).
   
3. 
   Reporting on financial information contained in interim reports, preliminary reports and voluntary announcements of annual results (5/2002).
   

SAICA has been working on various discussion papers following the corporate collapses and audit failures around the world.

February 2003 (30 Minutes)

Accountancy

The Higgs report published in the UK entitled “Review of the role and effectiveness of non-executive directors” recommends for listed companies that:

1. 
   At least half the members of the board, excluding the chairman, should be non-executive independent directors.
   
2. 
   The chief executive should not be the chairman.
   
3. 
   When appointed, the chairman should be independent.
   
4. 
   An independent director should be made available to deal with stakeholder problems.
   
5. 
   A nomination committee consisting of a majority of independent directors should make board appointments.
   
6. 
   Non-executive directors should serve for not more than two three-year terms.
   
7. 
   No individual should chair the board of more than one major company.
   

(Page 4)

The Financial Reporting Review Panel in the UK, which previously only acted on reference, will now become a proactive investigator. (Expect this to happen in RSA.) (Page 7)

The move to expense share options will result in companies abandoning their share option schemes with a negative impact on share ownership among employees. (Page 8)

Preliminary conclusions emanating from the Department of Trade and Industries report on revisions to the regulatory framework for the UK accounting profession propose that:

1. 
   The role of audit committees should be strengthened.
   
2. 
   Audit firm rotation would not be enforced.
   
3. 
   Partner rotation within a firm should take place every 5 years.
   
4. 
   Accounting firms should be more transparent.
   
5. 
   The Review Panel should be more proactive.
   

(These conclusions may affect the work being done in RSA on these matters at present.) (Page 11)

SEC in the US has softened the rules in the Sarbanes-Oxley Act by permitting tax advice to be given by auditors and by reducing the rotation period for partners from seven to five years. (Page 11)

By making non-executives act as corporate policemen, companies may find that they attract box-tickers and not entrepreneurs to their boards. This would ultimately be detrimental to company performance. The full Higgs report is available at www.dti.gov.uk/cld/non_exec_review. (Page 13)

The auditors ultimately yielded to management’s view of the accounting treatment to be adopted, which had the effect of overstating profitability and understating liabilities. They were well aware of the risks attending their audit yet failed to respond with appropriate diligence and resolve. (I am not going to reveal the name of the firm they are referring to! How often have you been in this situation?) (Page 17)

Pension funds are in crisis in the UK. The British have long pretended that their pensions are cheaper than they really are. Actuaries have under-priced pensions and not told trustees of the perils of mismatching their assets and liabilities. They have told their clients what they want to hear. Trustees, on average, are not qualified to take on the responsibility of running a pension fund. And the members of pension funds only find out the truth when they retire and the cupboard is bare! (Page 52)

The underlying theory in the Higgs Report is fourfold:

1. 
   Directors must have enough time to spend on the job.
   
2. 
   They must be smart enough to do the job.
   
3. 
   They need to be supplied with high quality information.
   
4. 
   The boardroom atmosphere must encourage contribution.
   

(Page 73)

The following commentary is provided on the expensing of employee share options:

1. 
   Option pricing models were designed for traded options and are not really applicable to restrictive options.
   
2. 
   The degree of estimation reduces the quality, transparency and comparability of financial statement information.
   
3. 
   It is silly expensing something if value has not been delivered, e.g. when the options do not get taken up.
   
4. 
   The cost of an option is not that of the company but of the shareholders.
   
5. 
   Larger companies can avoid the cost by buying shares on the market for the employees. (Interest forfeited on loans expensed?)
   

(Page 97)

Ron Paterson, as usual, hits the nail on the head when he explains that the difference between the UK (IAS) and the US standards is not rules v principles but more v less guidance. It would be a sad day if all the valuable guidance that has been built up at tremendous cost in the past is abandoned on the premise that principles do not need detailed guidance because they then become rules! (The more guidance we have, the better is the comparability of financial statements.) He says that one of the things that the US needs to do is to eliminate exceptions to the principles. However, sometimes exceptions are necessary when the principles result in silly answers! (Page 98)

The IASB has agreed that if an acquirer obtains control of an acquiree in a step transaction, the previous investment must be increased to its fair value, the gain or loss going through the income statement. Any previous revaluation of this investment lying in equity must be re-cycled to income. (So owner-occupied properties and plant are now being revalued through the income statement – madness! And, hey, if you had a bad year just buy another 1% of your 49,5% investment in X at an inflated sum and your can bring a massive profit into income!) (Page 103)

The IASB has agreed that if an acquirer already has control and acquires a further investment in a subsidiary, any gain or loss from re-valuing the interest goes directly to equity. Any gain or loss on disposing of a portion of the subsidiary also goes to equity. However, any gain or loss on disposal where control is lost must go to income. (One must wonder what mind altering drugs these guys are on!) (Page 103)

The IASB agreed that the minority interest in changes in equity should be disclosed in the changes in equity statement. Also, their share of income and expenses should be disclosed, but not on the face of the income statement. (Page 103)

The IASB agreed that the minority share of losses of a subsidiary should not be limited to the share capital. (About time!) (Page 103)

The IASB agreed that goodwill would not be adjusted by any subsequent recognition of deferred tax benefits. (Round and round we go.) (Page 103)

Charlton, the UK football club, writes the cost of players off to income over the period of their contracts and conducts annual impairment studies on its players. (Page 108)

The ICAEW’s Audit and Assurance Faculty has issued new guidance for the additional wording of the audit report following from the Bannerman case in Scotland. The purpose of the guidance is to manage the risk that a third party may inadvertently rely on the audit report. They are concerned that a perception may be created that the audit opinion is being downgraded by the new wording. Guidance is given to try to counter this perception. (I wonder when SAICA is going to pick up on this?) (Page 127)

Peter Wyman reminds us of the core values of our profession (integrity, objectivity, competence, diligence and courtesy) and sets out the nine principles the late Lord Henry Benson set out for the institute:

1. 
   Members should support the governing body of the profession.
   
2. 
   The governing body should set educational standards and standards of professional competency for entry.
   
3. 
   The governing body should set ethical rules and professional standards to be observed by the members.
   
4. 
   The rules and standards in (3) should be for the benefit of the public and not for the benefit of the members.
   
5. 
   Disciplinary action should be taken if the rules and standards are not adhered to.
   
6. 
   Audit work should be reserved to the profession to protect the public.
   
7. 
   Fair and open competition should be encouraged.
   
8. 
   Members should be independent in thought and outlook and should not allow themselves to be dominated by anyone.
   
9. 
   Members should give leadership in the field of learning to the public it serves.
   

(Back to old fashioned sound values.) (Page 128)

Members of the Scottish institute are halfway through the first five-year cycle of practice reviews. Their goal is to give constructive advice rather than destructive criticism. (Page 132)

The technical release on the changes to the wording of the audit report resulting from the Bannerman case suggests the following wording: “This report is made solely to the company’s members, as a body, in accordance with the Companies Act. Our audit work has been undertaken so that we might state to the company’s members those matters we are required to state to them in an audit report and for no other purpose. To the fullest extent permitted by law we do not accept or assume responsibility for anyone other than the company and the company’s members, as a body, for our audit work for this report or for the options we have formed.” This does not change the responsibility of auditors to their clients. (Page 135)

The UK’s ASB has published a statement on the operating and financial review that should accompany the financial statements of the company. This review should include a discussion on:

1. 
   The nature of the business, its objectives and the strategies adopted to achieve those objectives.
   
2. 
   The performance of the business for the past period, the main influences on performance and the trends and risks facing the business.
   
3. 
   The financial position, the capital structure and treasury policy and the factors that could affect that position. (Page 140)
   

The standard on retirement benefits has been postponed for SMEs in the UK. (Page 143)