Mafia Buzz Issue 3

Accountancy SA

George Papadakis says that the public expects auditors to detect fraud and actively search for it whereas the auditors do not see fraud detection as their responsibility. He suggests that auditors could go a long way to closing this expectation gap if they asked two simple questions:

1. 
   Does the company have an integrated fraud prevention plan?
   
2. 
   Is the plan fully and effectively operational?
   

It the answer to both questions is “yes”, the auditor should review the outputs of the plan to find out whether fraud is occurring and attempt to ascertain the extent thereof. If not, the auditor can investigate and report on the deficiencies and conclude and report that it is not possible to provide assurance as to the absence of fraud. He suggests that legislation should be promulgated which makes it obligatory for management to report on fraud and for auditors to express an opinion on management’s representations. (I totally agree! Supply the service that the public wants, for heavens sake!) (Page 6)

Andrew Costa covers some of the aspects of the Competition Act. If you are involved in a take-over or merger, read this article. (Page 10)

Carlos Correia discusses the “just in time” system of inventory control and compares it to the “just in case” system. He looks at what can be done to reduce the risks of the JIT system. (Page 14)

My article was on investment properties and private companies. (It is crazy that private companies have to comply with this statement!) (Page 27)

Penelope Webb’s article, which is truly delightful, looks at the tax situation where a pension fund pays out to the husband and the wife gets half of the amount on the divorce settlement. The husband pays the full amount of the tax despite only getting half of the amount paid out. (Page 31)

In the January journal one advert claimed that nine out of ten accountants recommend Pastel Accounting and another claimed that six out of ten accountants do not recommend any brand of accounting software! (Adverts should be subjected to audits!) (Page 35)

Business Day

Warren Buffett praised Amazon.com for its decision to account for stock options as an expense saying that it took courage to do so. A week later he bought $100 million of junk bonds in the company! (8^th)

Len Konar, the head of the review panel set up by the Minister of Finance to review the draft Accounting Profession Bill, says that there is a world wide trend towards more statutory regulation to prevent offences such as where auditors misrepresent the financial statements of a company. (25^th)

CFA Digest

Conventional wisdom says that an increase in the dividend pay out ratio signals an increase in future earnings and the share price. However, the alternative argument is that an increase in dividend pay out could signal that the company is entering the maturity phase of its corporate life and does not have further use of the cash. (Pick ‘n Pay is an excellent example of this.) (Vol. 33, No. 1, page 33)

It has been found that where members of defined contribution plans are given a choice between different asset profiles, they choose against their own interests. (I have seen this in RSA where young people choose high-income low-risk asset profiles.) (Vol. 33, No.1, page 68)

Citizen

There have been a number of cases in Europe where investors have been able to claim damages from investment managers where they specified clearly that they wanted low-risk investments and they were given high risk ones. People should not take poor investment service lying down. (I am predicting that such actions will start happening in RSA soon.) (8^th)

Financial Analysts Journal

The taxation of capital gains is wrong as it taxes gains from inflation, which is not ethical, and it encourages the government to permit inflation. (Vol. 59, No. 1, Page 4)

It has been found in the US that low dividend pay out ratios precede low earnings growth and high dividend payout ratios precede high earnings growth. (So much for the sustainable growth rate formula!) There could be two reasons for this:

1. 
   Where managers are confident that earnings are going to grow they are happy to pay out higher dividends. Conversely, they would not increase dividends if they cannot foresee an increase in profits.
   
2. 
   Some managers withhold profits to empire build. This seldom results in earnings growth. (Vol. 59, No. 1, Page 12)
   

The editor, Robert D Arnott, points out that dividends DO count. He shows that over the past 200 years, equities in the US earned a return of 7,9% p.a. A breakdown of this return is:

• 
  From dividends – 5,0%
  
• 
  From growth – 2,3% (real 0,8% and inflation 1,4%)
  
• 
  From falling yields – 0,6%
  

If it were not for dividends, returns would have been negative! (Where are my old students who used to argue that dividends are irrelevant?) (Vol. 59, no.2, page 4)

It has been “discovered” in the US that the AFTER tax yield on T-bills was –1,34% between 1926 and 2000. The notion of a negative equilibrium interest rate may have far-reaching implications for many of our economic institutions and models, most of which assume a positive interest rate. In light of these findings commonly taught concepts such as time value of money should be reconsidered. (I have been trying to explain this for years. One of the large auditing firms fought with me for two years about this concept. Recently I had an ex-merchant banker walk out of a valuation session when I said that one should use an after tax return to discount dividends. His argument was “We don’t do it this way where I come from”. It is amazing that the US is only catching up with the more enlightened South Africans now!) (Vol. 59, No. 2, page 18)

Financial Mail

Later this year, if all goes according to plan, anyone who gives financial advice to clients, or attempts to sell financial products, will have to be licensed by the authorities. Any unlicensed advisor who tries to sell a life insurance policy, or puts together an investment plan for a client, will be operating illegally. (The next step is to target teachers of the subject? I will have to stop writing articles on the subject until I get my licence. What’s next? A licence to make love?) (4^th, page 53)

“The rule of thumb is that you hold in bonds your age as a percentage.” (This rule is dumb. One must take into account the amount you have to invest. If you only had R1 million to retire on at the age of 60, you would invest 40% in equities! This rule of thumb needs to be changed.) (4^th, page 79)

The ex-CFO of WorldCom has been indicted on a further 11 chargers that carry jail terms of up to 120 years. (25^th, page 8)