Mafia Buzz Issue 3

Star

General Electric’s pension plan lost $5,25bn in 2002. However, because of GAAP, this loss is watered down due to the corridor and the ability to spread it over the future. Commentators complain that the company should tell the truth and not stick strictly to GAAP. (11^th)

Tecktalk

The IASB decided to hold round table discussions in London with respondents to the statements of financial instruments. (They lived to regret this decision!)

The IASB agreed to scrap the presentation of “expected return on fund assets” in the employer’s income statement but to include the actual return on plan assets. This means no more smoothing will be permitted in future for changes in the values of plan assets. (And so it should be.)

The IASB has agreed to programme consolidations and special purpose entities for review.

The IASB has confirmed its intention to exclude investments held by venture capital organisations from the scope of the statement on equity accounting.

Fun Corner

A cockroach will live nine days without its head before it starves to death. (Finance Week, 31 March, page 66)

The department of correctional services says it may stop using the word “prisoners”, which is damaging psychologically, and seek a “stigma-free” term for “people under correction”. (Financial Mail, 14 February, page 8)

Rome did not create a great empire by having meetings – Romans did it by killing all those who opposed them. (Finance Week, 5 February, page 66)

Many patients, usually men, come in because their spouse recommended a hearing check. Their hearing is usually fine, the cause appearing to be SHD (selective hearing deficiency) – a person gets used to his spouse’s voice and unintentionally doesn’t respond. In some cases, of course, it may be intentional.

A man goes to a GP and says “I’ve got a sore tongue doctor”. The GP looks into his mouth and exclaims “Gosh, you’ve got a bad case of glossitis”. The man, pleased to know what his problem is, goes home, looks up the dictionary and finds that “glossitis” is the medical term for a sore tongue.

What You Always Wanted to Know But Were Too Afraid to Ask

What is the Difference Between a Value Investment Manager and a Growth Investment Manager?

Value mangers argue that future growth is largely speculative, unpredictable, prone to exaggeration and susceptible to collapse. Intrinsic value is what counts. Growth managers, on the other hand, look to projected growth in earnings to find value. As in all these debates, there is some truth in each argument. One should look at both aspects when valuing an equity share. (Financial Mail, 21 February, page 76)

What is a Hedge Fund? Should I be Investing in One?

Hedge funds do various things but the basic idea is that they hedge by investing to protect the downside in another investment e.g. they could buy Pepsi and short Coke. Another example would to buy the ten best stocks in an index and short the ten worst. However, they are also quite happy to use borrowings to gear their returns. The result is that any superior returns come packaged with high risk - there have been some major hedge fund blow-ups. They tend to be secretive, e.g. when one investor asked a fund manager about his position he was told: “None of your business”! (Sounds like our own Jack Milne?) In the US, hedge funds do not have to report their performance so published results are questionable. Managers of these funds do extremely well, the usual deal being 20% of the profits. When the managers are under pressure to perform, they do a Nick Leeson and pile on the risk to get the returns. (Fortune 31 March, page 70)

What Does that Foreign Exchange Jargon Mean?

Spot rate: What you would pay if you wanted to purchase currency immediately.

Forward contract: An over-the-counter (OTC) agreement to purchase a stipulated amount of currency at an agreed exchange rate at a future date. These contracts, unlike futures, are not traded.

Fixed and optional forward contract: An agreement to purchase currency at any time within a specified period.

Swap: A change in a forward contract.

Forward rate agreements (FRAs): Agreements to fix a lender’s or borrower’s interest rate in future.

Futures contract: A contract to deliver a currency, commodity or financial instrument at some future date at a fixed price. These are traded instruments.

Currency option: A right but not an obligation to buy or sell a currency at a specific price within a predetermined time frame. A call is the right to buy and a put is a right to sell.

Pip: A fraction of a move in the exchange rate.

(Business Report 31 January)

What is Triple Bottom Line Reporting?

1. 
   Environmental sustainability.
   
2. 
   Positive relationship with stakeholders.
   
3. 
   Support of universal human rights.
   

(Citizen 15 April 2003) [Got it wrong!]

April 2003 (30 Minutes)

Accountancy

The Higgs report on corporate governance in the UK is causing waves. Some of the points of disagreement are the proposals to:

• 
  Appoint an independent director to listen to shareholders’ concerns – this could be divisive
  
• 
  Appoint an independent board member other than the chairman to chair the nomination committee – this could undermine the chairman’s role
  

It is also felt that the whole thing will become a box ticking exercise. (Page 9)

It has been found that environmental problems emerge in four out of five deals undertaken despite environmental due diligence being undertaken. There is, therefore, a need to improve this aspect of a due diligence investigation. (Page 10)

The UK is fighting the requirement by the US PCAOB to force UK auditors who audit US company branches or subsidiaries to register with it. (Page 13)

Good management is relatively straightforward – known as common sense. It is good solid work done diligently. Fancy management theory and current fads do not really apply. Good management is rather a dull activity. It is much more fun to thrash about destroying value. Financial analysis should be augmented with behavioural analysis. Watch out for deal making that makes no sense other than satisfying investment bankers who demand “corporate activity” to spice up the company’s profile. (Page 21)

Referring to the Higgs report: One cannot make a person prudent or wise by prescribing procedures to be followed. (Page 22)

Deloitte dropped the audit of Huntingdon Life Sciences due to pressure from an animal rights protest group that got hold of the addresses of the audit staff and harassed them. (Who wants to be an auditor?) (Page 24)

The number of auditing firms willing to audit large listed companies could diminish in the future as the risks of such assignments begin to outweigh the fee income. (Page 27)

Regulators in the UK are considering quarterly reporting used in the US. This idea is meeting resistance for the following reasons:

• 
  Additional costs will be incurred
  
• 
  Will focus on producing figures instead of getting on with the business
  
• 
  Will encourage short-term approach to running the business
  

Arguments for include the avoidance of annual surprises and involvement of the auditors during the year (more fee income for them!). (Page 41)

Ahold, the third largest supermarket group in the world and one of the safest investments one could find, has had to restate its published results - $7 billion of equity has disappeared. This scandal is becoming known as the European Enron. (Page 42)

The new Proceeds of Crime Act could result in a UK accountant spending 14 years in jail if he or she assists a client without asking questions about the source of the client’s income. (Page 46)

A detailed survey conducted by the 2020 Consulting Group in the UK found that one third of clients are seriously considering discarding their accounting firms. Most clients are happy with the audit and accounts preparation, tax advice and general business advice. Complaints included the lack of promptness, responsiveness, fresh advice and innovation. And, of course, there are always complaints about the fees. One interesting point is that clients would like to be billed monthly for the fees. (Page 60)

A straw poll at a recent ICAEW forum set up to discuss goodwill and intangible assets preferred the amortisation approach to the impairment only approach. (Page 75)

The IASB is contemplating the publication of an ED on revenue by the end of 2003. The UK, in the meantime, has published an ED covering certain aspects of revenue recognition:

1. 
   Only when a seller performs does it have the right to be paid and it is then when revenue should be recognised.
   
2. 
   When payment is received in advance, the liability is reduced as performance takes place.
   
3. 
   If a service is linked and cannot realistically be sold separately, e.g. a software licence linked to maintenance and upgrades, revenue should be spread over the contract period. This is in line with US GAAP.
   
4. 
   In a bill and hold arrangement, revenue is recognised when the seller has completed its performance obligations (the goods are manufactured and fully ready for delivery).
   
5. 
   The entry for estimated returns is to reduce sales and cost of sales (if the inventory still has value) and credit a provision.
   
6. 
   Where the seller acts as principal (exposed to the majority of the risks and rewards associated with the transaction), the gross amount is included in revenue. Where it acts as agent, only the commission is included in revenue. An undisclosed agent will usually be treated as a principle. (Page 76)
   

Some points from a discussion with IASB members:

1. 
   The US scandals are not necessarily indicative of poor accounting principles; the companies did not follow the rules.
   
2. 
   There is more in the perception than in reality of principles versus rules-based accounting. Every principle needs guidance (a rule) for there to be consistency of application.
   
3. 
   A problem in the US was that companies took the position that if you do not have a rule then you can do what you like.
   
4. 
   The next six months is critical for the EU. If IFRS is not adopted, US GAAP will apply by default.
   
5. 
   There is an initiative in the IASB to come up with a simplified version of IFRS for emerging countries and SMEs.
   
6. 
   In most emerging market economies, accounting is heavily tax-based. The financial statements are substantially a tax return. It is necessary to alert people that financial statements do have other uses. (A small private company that has no borrowings?)
   
7. 
   The IASB has had to decide that its objective is to work primarily on rules for listed companies and possibly to define some of the measurement and recognition criteria for non-listed companies around the world. (The light is slowly dawning!)
   
8. 
   IAS39 is a botch. Standard setters think that financial statements are to assist users to forecast future cash flows but preparers want to use them for management reporting purposes.
   
9. 
   Fair value accounting will introduce so much subjectivity into the numbers that they will lose their usefulness.
   
10. 
    We looked at numerous different models for measuring biological assets at cost. We then realised that the fair value model made sense for the agricultural sector. (Who were “we”?)
    
11. 
    If we want IFRS to be truly international they must give priority to the SME project. (I do not agree. This has nothing to do with the IASB. They should confine themselves to listed and other economically significant companies.) (Page 78)
    

The UK will be abandoning some of its own accounting rules in favour of IAS rules, e.g.:

1. 
   Linked presentation will no longer apply (this made a lot of sense – sad to see it go).
   
2. 
   The gross equity method for joint ventures (good riddance).
   
3. 
   Use of the “correct” discount rate to measure post-retirement obligations. (This battle will be won some day!)
   
4. 
   Measuring biological assets at cost. (One day we will be back to cost.) (Page 85)
   

I do not normally comment on tax matters. However, it is interesting to see that the UK Revenue is attacking schemes where one spouse donates shares to the other to reduce the effect of tax (the recipient is taxed at a lower rate on the dividends received). I hear that SARS is looking into the same form of attack on interest paying investments.) (Page 104)