Mafia Buzz Issue 3

Financial Mail

Frikkie de Villiers of Accenture SA says that innovation in business governance is being suppressed by placing the accent on corporate governance aspects such as accountability and responsibility following the Enron and WorldCom affairs. He says that directors should regularly ask themselves whether their products, services and processes could be better, what the alternatives are and which ones will deliver optimal results. He believes that directors should seek independent professional advice in these matters. (5^th, page 15 of innovations)

If you invested in the Alsi in 1960 using a buy and hold strategy, you would have increased your investment by 11,2 times. If you had been out of the market during the best 42 months, you would have increased your investment by 0%. However, if you had been out of the market in the 42 worst months and in the market during the rest of the period, you would have increased your investment by 23 400 times. (If this information is correct (note, if) your strategy for making millions is easy – buy and hold, but anticipate downturns and stay away during the downturn. If anyone knows how to achieve this, please let me know.) (19^th, Page 87)

Fortune

It appears as if the improvements in second quarter earnings in the US have got nothing to do with improvements in operating profits but are due to:

1. 
   Postponement of capital expenditure resulting in lower depreciation charges.
   
2. 
   A declining exchange rate of the dollar.
   

Due to the scepticism of accounting results users are referring to the tax returns of companies as it is unlikely that companies will overstate their taxable incomes. The gap between accounting profits and taxable profits did widen with all the accounting tricks being used to boost profits. (A good ratio to calculate here would be current tax in the income statement to net profit before tax. If that rate is going down, investigate the causes.) (22^nd, Page 19)

Techtalk

The following standards are not scheduled for change until before March 2004, other than for consequential and editorial changes: AC 109, 111, 114, 115, 118, 119, 120, 124, 127, 130, 134, 136 and 137.

The following standards will contain limited changes: AC 101, 103, 104, 105, 107, 108, 110, 112, 123, 126, 132 and 135. We hope that they will meet their October (now November) deadline.

The following standards will be issued by March 2004: AC 119 (they mean 117), 128, 129, 131 (first phase), share based payments and insurance contracts (first phase).

The exposure drafts on the following standards are due by March 2004:

• 
  Employee benefits
  
• 
  Business combinations (second phase)
  
• 
  Income taxes
  
• 
  Reporting performance
  
• 
  Financial risk disclosures
  
• 
  Financial instruments (both)
  

On the auditing side the following should be studied:

• 
  An ED on reviewing interim financial information
  
• 
  A guideline issued on money laundering by the PAAB
  
• 
  The IFAC code of ethics
  

And if you have nothing better to do, remember that you can now attend the Auditing Standards Board meetings as they are now open to the general public. You had better book well in advance as I am sure that the public gallery will be full. They do not say whether or not there will be a charge or whether biscuits and teas will be served?

Maneo

The September issue of Maneo makes for very interesting reading. There are seventeen pages dealing with disciplinary matters – the PAAB is really being seen to be taking tough action! There was one aspect, however, that worried me: a practitioner was found guilty of being unprofessional in trying to extort his fee for work done for a client. Does this mean that I must fire my debt collectors who pull teeth and fingernails and break toes for non-payment of my fees?

Arriving at Maintainable Earnings

One of the major problems one has when performing a valuation is to arrive at a figure that is representative of the long-term maintainable earnings of the entity being valued. An article published by the AIMR® on measuring earnings has the following interesting points:

Alternative measures of earnings encountered out there are operating earnings, normalised earnings, pro forma earnings, normalised/standardised earnings, EBITDA, net income and comprehensive income.

Different rationales for arriving at maintainable income are operating v non-operating, recurring v non-recurring, core v non-core, within management control v outside management control, and in RSA, trading profits and losses v capital gains and losses.

Here are some examples of income statement items seen recently:

1. 
   Restructuring costs (Unilever €1,5 billion, Cisco $1,2 billion)
   
2. 
   Disposal gains (Unilever €900 million)
   
3. 
   Intangible asset/goodwill amortisation (Unilver €1,4 billion, Cisco $1,2 billion)
   
4. 
   Excess inventory charge (Cisco $900 million)
   

Comprehensive income is the only measure that companies cannot manipulate as it includes all items. (No imagination! Fair value accounting can be manipulated at will, which will impact on comprehensive income.)

Pension fund accounting provides a challenge for the analyst. They argue that the net charge for pension fund costs is misleading and want the interest charge, the return on investments and the current service cost to be separated.

The IASB is developing a new income statement – will it enlighten or confuse the user? Let us wait and see.

Aggressive Accounting

The AIMR® published an article to assist analysts to identify aggressive accounting. Here are some ideas:

1. 
   Compare earnings per share growth with growth in revenue.
   
2. 
   Compare gross margin growth with EPS growth.
   
3. 
   Analyse the policy for revenue recognition.
   
4. 
   Identify the source of growth, e.g. coming from acquisitions?
   
5. 
   Beware of the cutting of discretionary expenses.
   
6. 
   Check whether profits are generating cash flows.
   
7. 
   Ask whether the application of GAAP is resulting in economic reality.
   
8. 
   Beware of distraction tactics such as focusing on EBITDA.