Mafia Buzz 2003
3.
January 2003 (20 Minutes)
Abbreviations Used Mafia Buzz 2003
(Question: Why is the word “abbreviation” so long?)
AIMR = Association for Investment Management and Research
APB
= Accounting practices board
ASB
= Accounting Standards Board of the UK
APB
= Accounting Practices Board
ASB
= Accounting Standards Board of the UK
BEE
= Black economic empowerment
DC
= Defined contribution
DIY
= Do it yourself
EBITDA = Earnings before interest, tax, depreciation and amort.
EC
= European Commission
ED
= Exposure draft
EU
= European Union
FRC
= Financial Reporting Council
FSB
= Financial Services Board in RSA
GAAP = Generally accepted accounting practice
IASB
= International Accounting Standards Board
IAASB = International Auditing and Assurance Standards Board
IAPS
= International auditing practice statement
ICAEW = Institute of CAs of England and Wales
IFRS
= International financial reporting standards
JSE
= Johannesburg Stock Exchange of S.A.
PCAOB = Public Company Accounting Oversight Board in US
SAICA = South African Institute of Chartered Accountants
SARS
= South African Revenue Services
SEC
= Securities Exchange Commission of the US
SERP
= Supplemental executive-retirement plan
SHAC = Stop Huntingdon Animal Cruelty
SME
= Small and medium enterprise
SOX
= Sarbanes-Oxley
SMP
= Small and medium accounting practice
SOX
= Sarbanes-Oxley
SEC
= Securities Exchange Commission of the US
Accountancy
One of the great losers of the Enron affair was the reputation of
the audit. The world does not understand what an audit is for and
the profession is looking to do a selling job. One suggestion is
that a special qualification for auditors be launched to show the
world that auditors have special training and expertise. The
suggestion is to have a college of auditors. Most big firms have
their own specialist training so this is not a solution for the big
firms. (Maybe the smaller firms should pool their resources to
give their staff the necessary training. They need our Henk
Heymans in the UK!) (Page 7)
PwC caught the profession by surprise when they changed the
wording of their audit opinion as a result of the judge’s comments
in the Bannerman case in Glasgow. A bank relied on the audit
opinion given by the auditors of Bannerman in making a loan.
(See later for action taken by the UK in this regard.) (Page 9)
MyTravel has caused the UK profession an embarrassment – they
were smugly saying “It can’t happen here in the UK”. Accounting
irregularities ranging from aggressive revenue recognition to
misallocation of costs took place. (Why couldn’t they take the
knock and blame 9/11? Why do they have to try to deceive their
shareholders and loan holders?) (Page 9)
John Shuttleworth lists the following lessons to be learnt from
2002:
1.
2.
Investors should see pension funds for what they really are
and that is collateralised debt.
Equities do have a higher expected return than bonds –
maybe this is why they give a lower return!
We re-learnt the universal truth that equities are risky. One
must remember it is not what can go wrong that is important
but how badly it can go wrong.
4. Pension funds in the UK are in serious trouble. (Page 46)
Are your really prepared for a catastrophe? Have you got sound
business continuity management plans in place? You can’t wait
for it to happen. You have to prepare for the worst. The IT
function is obviously important but one must have a holistic
approach to the problem. One should look at the four P’s: people,
processes, premises and providers. Not only should the plan be in
place; it should be tested. Small businesses need to ask a series of
“what if” questions. Examples are: “What if there is a break-in?”
“What if my hard drive blows?” “What if there is a lightening
strike?” “What if my car gets stolen with my client’s files in the
boot?” “What if I get seriously ill?” If you haven’t done it yet, it is
time to plan. (If you plan, it tends not to happen!) (Page 49)
The Enron affair has made auditors look not so much at what has
happened in the past but as to what can trip you up in the future.
(Page 52)
Business travellers need to take precautions to reduce their
vulnerability to danger. Some ideas are:
1.
2.
3.
4.
5.
Stand or sit where you can see what is going on.
Take note of emergency exits.
Walk in well-lit heavily travelled streets – avoid short cuts.
Face the traffic when walking.
Stand near the control panel in a lift and check the hallway
before exiting.
6. Keep mentally and physically fit – stay alert.
7. Dress modestly – be the grey man or woman.
8. Keep your personal details hidden from sight and keep copies
of vital documents, e.g. passports, visas, etc.
9. Beware of scams to separate you from your luggage.
10. Keep a dummy wallet with some money in it.
11. Use a door wedge for extra security in your hotel room.
12. Don’t hang a “Make up room” sign on your door. (Page 57)
PwC audit chief Glyn Barker says that Enron has made all the
players realise what they should have known all along and that is a
good audit is not an imposition to be tolerated but an asset worth
paying for. (Page 78)
Sir David Tweedie says that the IASB favours an approach that
requires the company and its auditor to take a step back and
consider whether the accounting suggested is consistent with the
underlying principle. This approach requires that companies and
their auditors exercise professional judgement in the public
interest (this is where the whole system will fail David – can you
rely on the integrity of all concerned?) The intention is to reduce
the amount of guidance given and to leave more up to the
judgement of the preparers and their auditors. (I wonder if the
IASB has done a survey among users to get their feelings on this
approach? Based on my limited survey, users want certainty and
comparability.) (Page 89)
Andrew Lennard argues that entry values are a sound basis for
assets and for liabilities. If an asset is bought for 100, it should be
measured at 100. Profit should not be taken before the asset is
sold. Only then should profit be recognised. (Logical!) On the
other side, if a bank receives a deposit payable on demand from a
customer of 100 it should be recorded at 100. If the deposit is
available to the bank for a period of time and the bank can make a
return from the use of that deposit it does not mean that the bank
can reduce the liability to its present value and take the profit
before it has been earned. (I like this argument. It all comes down
to: “When is value created?”) (Page 90)
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Mafia Buzz 2003
Ron Paterson suggests that we should support the move to
expense employee share options. (I also think it is the right thing
to do but what worries me is that if Ron agrees with David, then
something must be wrong!) (Page 92)
The proposals on business combinations are:
1.
2.
Only the purchase method will apply in future.
A restructuring provision will only be permitted if it meets
the definition of a liability at the date of the combination.
3. If a value can be attached to the contingent liabilities of the
acquiree at the date of acquisition, a provision can be made.
4. Goodwill will no longer be amortised but will be tested for
impairment annually.
5. If any negative goodwill arises, the measurement of the
identifiable assets, liabilities and contingent liabilities should
be “reassessed” and if there is anything left over after this
“reassessment” it should be recognised immediately in profit
or loss.
Consequential amendments will be made to the statements on
intangible assets and impairment:
1.
When impairing a cash-generating unit, one will not
automatically assume that goodwill takes the first knock.
2. Reversal of goodwill impairments will be banned.
3. The requirement in the definition of an intangible asset that it
be held for use in the production or supply of goods or
services or for rental to others or for administrative purposes
is to be withdrawn. (I wonder why?)
4. The 20-year rebuttable presumption for the useful life of an
intangible asset is to be withdrawn.
5. If the intangible asset is considered to have an indefinite life,
it should not be amortised.
(Page 94)
Phase 2 of business combinations contains the following
proposals:
1.
If less than 100% of a business is acquired, the full 100%
goodwill should be raised. (I do not agree with this!)
2. Whichever side of the transaction provides clearer evidence
should be used to measure the fair value of the acquired
entity (the value of the consideration paid or the value of the
entity acquired).
3. Minority interests would now be part of equity, but
separately disclosed.
(Page 100)
The IASB considered whether or not defined benefit plans should
be consolidated but concluded that this topic was too hot to handle
at present! (Page 100)
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 nonUSA 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. (7th)
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. (29th)
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. (17th, 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. (31st, 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!!!). (29th, page 8)
More than 70% of pension fund portfolios recorded losses last
year. (29th, page 8)
An article encouraging you to invest overseas is called “Giving
your money wings” – very appropriate, you will never see it
again! (29th, page 46)
Techtalk
The following exposure drafts have been issued:
1.
2.
3.
Share based payments (www.saica.co.za).
Reporting on compliance with international financial
reporting standards (www.paab.co.za).
Audit risk (www.paab.co.za).
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Mafia Buzz 2003
(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.
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 following new pronouncements have been made:
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)
1.
2.
Enquiries regarding litigation and claims (SAAS 502).
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.
2.
3.
Subordination agreements (2/2002).
Letters of support (3/2002).
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.
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:
The Higgs report published in the UK entitled “Review of the role
and effectiveness of non-executive directors” recommends for
listed companies that:
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.
1.
February 2003 (30 Minutes)
Accountancy
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)
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
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Mafia Buzz 2003
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)
Accountancy SA
Douglas Warden and Jennifer Roeleveld believe that it is time for
SARS (the tax people, not the virus) to give allowances for
goodwill and intangible assets. These assets are now subjected to
capital gains tax so why not bring them into the normal tax fold?
(One chance!) (Page 6)
Glen Mouton says that you can protect yourself to a certain extent
against fraud by ensuring that opportunities do not arise, that
fraudsters believe that they will be caught and that they are made
aware that the consequences of their actions will be severe. He
then goes on to give some procedures that should be in place, e.g.
checking references, access controls, reconciliations, dual
signatures, segregation, management review, etc. – the stuff of
text books. But it is good to be reminded of these things now and
again. (Page 11)
Paul Sulcus says that one needs to be prepared for a conversion to
a new IT installation. He says that in practice project deadlines
are not met, there are cost overruns, anticipated benefits are not
achieved, systems don’t work as expected and staff become
demoralised. He sets out a checklist for success and gives case
studies on how IT can be successfully implemented. (Page 12)
Malcolm Dunn says that CFOs are playing a larger role in the
development of strategy for companies because of their analytical
skills. (I hope that CFOs are able to live up to the high status given
them in this article – a good sales job for CFOs!) (Page 15)
Lance Williams and Rudolf Dreyer discuss the proposals for
accounting for share based payments. They say that if Investec
had done this, their earnings would have reduced by 4,2%. (From
my feedback, it appears as if 5% is the average impact.) Some of
the points made are:
1.
For employee share based payments, value is determined at
grant date and expensed over the period of the services given.
2. For non-employee share based payments, value is determined
at the earliest of grant date or delivery date and expensed or
capitalised on delivery of the goods or services.
3. Re-measurement on the reporting date of the financial
instrument issued is not made if it is a share based payment.
4. Using a trust does not enable one to escape the accounting
standards as the ED has catered for this aspect. (Page 16)
Mario Pienaar writes about differential reporting. (I believe that
the time has arrived for action and not more surveys and articles.
Let’s stop talking the talk and start walking the walk!) (Page 27)
SAICA issued circular 1/2000 on MC CPE, which was based on
IFAC’s IEG2. However, IFAC is presently replacing IEG2 with a
new CPD programme. The responsibility for CPD has been taken
away from SAICA’s CPE department and transferred to the ADU.
SAICA’s new CPD committee has been constituted to look into
compliance with IFAC’s requirements. (I sincerely hope that the
new committee will stop talking in alphabets.) (Page 29)
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Mafia Buzz 2003
My article was designed to debunk the PE ratio method of valuing
equity investments. (Page 31)
Penelope Webb warns tax cheats to keep their mouths shut. (I
heard a lovely story the other day: a tax assessor was on his
journey to the coast for a well-deserved break when an expensive
car came up behind him. The driver flashed the car’s lights and
pulled a finger at him. He took down the car’s number and on
returning from holiday investigated the driver. He found that the
salary being declared could not justify the car being driven. The
driver is now in jail, not for reckless driving but for tax fraud!
Don’t you love it! Another idea for Penelope.) (Page 33)
Citizen
Bryan Hirsch asks why investors keep buying high and selling
low. His advice is to keep a cool head, don’t allow emotions to
rule decision making. Assess the fundamentals. (5th, page 24)
Rudi Giuliani’s book “Leadership” sets out the principles he
followed when mayor of New York. They are:
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
Surround yourself with great people
Formulate and communicate beliefs
See things for yourself
Set the tone – set an example
Everyone is accountable all the time
Under promise and over deliver
Prepare relentlessly
Loyalty is a vital virtue
Don’t assume anything
Stand up to bullies
Weddings are discretionary, funerals mandatory (17th)
Financial Mail
In the past 10 years the number of companies listed on the JSE has
fallen from 670 to 470. Last year alone saw a loss of 80
companies, mainly small ones. About 36% of the shares on the
main board trade at less than 100 cents per share. The top 20
shares on the board account for two-thirds of the total market cap.
(7th, page 34)
A Japanese hedge fund wiped out $300 million in just seven days
of last month after a series of deals that makes Nick Leeson look
like an amateur! (14th, page 90)
Trevor Manuel has appointed a panel of 17 people to advise him
on matters of auditor independence, corporate governance and the
regulation of auditors. The panel is due to report to him by 31
July. (21st, page 30)
Nigel Payne’s report on the Cytech affair states that he was happy
that the process followed to arrive at the valuation was acceptable.
(But did it meet basic ethical standards required from directors?)
(21st, after page 48)
The Woodmead office of SARS handles 8 000 tip-offs per month
from anonymous callers or reports made to their offices.
Disgruntled businessmen have labelled the 113 qualified forensic
investigators “shock troops” but SARS’s attitude is “if the
taxpayer does not keep his or her house in order and plays games
with us, we have no option but to get aggressive”. (28th, page 19)
Financial Times
Investors are greedy, make stupid decisions and should share part
of the blame for their losses. People only see the virtues of
diversification once something has fallen. They went haring into
technology stocks three years ago and now they want to leave
them and go buy larger houses at the top of the property market.
(Simon Davies of Threadneedle Investments) (4th)
Finance Week
A circular is expected from the Registrar of Pension Funds stating
that they do not have the authority to exempt any pension fund
from the requirement to repay surpluses in terms of the Pension
Funds Second Amendment Act of 2001. It appears as if there will
be a long wait for past members to be paid out and they must not
expect to receive anything substantial as markets have been in a
downward spiral over the past few years. Past members of
pension funds going back to 1 January 1980 should ensure that
they notify the pension funds of their contact details. (5th, page 49)
“Your magazine being very positive on indexing and was a great
proponent of Satrix 40 about a year ago. May I suggest that you
take a look at how that has done over the last year. As you see, it
is not only the investment mangers who get it wrong from time to
time but also journalists.” (Dig, dig.) (12th, page 7)
Don’t throw your good money after bad. Take your money out of
whichever insurance company has it and invest it yourself. For
any investor with a good sense of judgement and who is prepared
to invest conservatively, there is nothing more satisfying in the
investment world than the growth and returns you can obtain
yourself. (12th, page 7)
Around $13 trillion has been wiped off global stock markets over
the past two years, the worst bear market since World War 2.
(12th, page 8)
Afgri is rumoured to be facing an unrealised loss of as much as
R200 million. Its trading update admits to a “mismatch” between
buying and selling contracts. Thanks to a change in accounting
policy, the group is able to reflect this loss directly in equity,
rather than to take the hit in the income statement. (Isn’t GAAP
just marvellously accommodating?) (12th, page 13)
Switching an appropriate long-term investment strategy because
of short-term discomfort is the wrong thing to do. (19th, page 46)
Zimbabwe changed its exchange rate for exporters from Z$55 to
Z$800 to the US dollar. (28th, page 8)
Tongaat-Hulett has changed its accounting policy by adopting the
statement on agriculture and by valuing maize futures and option
contracts. The effects are (R’ millions):
1. An increase in growing crops by 132
2. A reduction in plant and equipment by 84 (?)
3. A reduction in working capital by 89
4. A reduction in deferred tax by 14
5. An increase in derivative assets by 9
6. A reduction in equity by 18
Profits for the current and previous year were adjusted by R9
million. (28th, page 63)
Fortune
The real reason why AOL Time Warner is such a dog is not
because of a clash of cultures, not because of accounting
irregularities, not because of a drop in revenues but because the
price of the deal in the first place was insane. And the painful part
is that this was perfectly clear at the time. (So why did no one
stand up at the time and say so?) (3rd, Page 15)
A stock is only worth what you can get out of it, i.e. dividends and
not earnings. “A cow for her milk, a hen for her eggs. And a
stock, by heck, for her dividends. An orchard for her fruit, bees
for their honey. And stock, besides, for their dividends.” This
was written after the 1929 crash. The stock market and corporate
America are again in ill repute. And after years of ignoring
dividends, the nation is falling in love with them all over again.
Even Microsoft has recognised the “new” understanding of what
value really is and has stunned the market by paying its first ever
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Mafia Buzz 2003
dividend. (It is amazing how it takes a disaster to get people
thinking clearly again.) (3rd, page 48)
Techtalk
1.
SAICA has issued circular 7/2002 on headline earnings. This
circular sets out rules for arriving at the measure.
2.
The APC has released an ED on business combinations, the
details of which are dealt with elsewhere in Mafia Buzz.
3.
The ASC has issued a circular on agreed upon procedures
performed for long term insurers.
4.
The IAASB has issued three documents that are critical to its
operations, namely its terms of reference, its preface and its
policy on black lettering.
Ms Sue Ludolph has been appointed the technical director in
charge of accounting. I wish her well. This is not a position
anyone can handle. I have seen many come and go. One needs to
be tough to handle it. I had the pleasure of lunching with her and
believe that once she has absorbed some battering and a few
knocks that come with the job, she will grow into the position. I
think that she has what it takes. Good luck Sue.
March 2003 (35 Minutes)
Accountancy
The share-price of Tenon, the UK’s accountancy consolidator, has
crashed. (When they tried to start this in RSA I warned that this
would probably happen. Accountancy is a professional personal
service, not a commodity that can be sold.) (Page 6)
Deloitte and Touche are under attack by animal rights groups
because of their association with a company that tests drugs on
animals. (Who wants to be an auditor?) (Page 7)
E&Y are delighted to have won the case against them by
Equitable Life over the inadequacy of the annuity rates charged by
the company. Where do the directors’ duties end and the auditors’
duties begin and end? For the directors to blame the auditors for
not being aware of the risks of the businesses they managed is a
joke. This is a major victory for the whole profession. (Page 9)
There is a move to crack down on pro forma information
published by companies with the intent to mislead. (Page 12)
In the first few pages of this month’s journal, three of the big four
auditing firms are under the whip for something or other!
Auditing is not a good place to be at present.
It does not matter how many rules you put in place but the quality
of the people and the culture that matter. We need to attract
quality people to the profession who have the capacity and
courage to distinguish between right and wrong. (Page 19)
Following on from the Bannerman saga, why should financial
statements be reliable for the shareholders and not for the lenders?
Auditors should have sufficient confidence in their procedures and
standards for the financial statements to be useful to all parties.
Otherwise, the audit becomes almost valueless. (Page 19)
No degree of regulation will overcome the certainties that
corporate failure is inevitable and the auditors will be blamed.
The reality is that financial difficulty, financial collapse and the
temptation to hide or distort reports of poor financial performance
are the natural consequences of the market system. (Page 20)
In the UK 24% of chartered accountant financial directors are
alumni of their company’s auditor. (So why is the UK not full of
accounting disasters?) Only 7 CFOs in the top 100 companies
trained outside the Big Four auditing firms. (Page 29)
General consensus is that the Higgs report does not provide
additional responsibility for non-executive directors. It merely
describes their role and responsibility. (Page 52)
After a year’s work a 2700 page report on the deceptions of Enron
and its advisors spell more uncertainty for the profession. The
senators who were responsible for the Sarbanes-Oxley Act have
taken the cause up with renewed vigour. More than 5000 Enron
employees lost their pensions. Managers tried to fill their pockets
before the crash. The scope of the wrongdoing and the complexity
of the devices used will strain public perceptions of the ethics of
the profession. Tax shelters were designed not only to save $2bn
in taxes but to generate $2bn of fictitious profits for Enron. The
total taxes evaded in the US alone totalled $50bn. Tax advisors,
including banks and audit firms, received $88m in fees. (Page 57)
The ICAEW has decided to postpone practice review for a year
because of a failure to persuade practitioners of the benefits to be
received. Smaller practitioners were dead against it. (I could
never understand why small practitioners in RSA were so passive
when they proposed it here.) (Pages 65 and 66)
The cost of employees leaving is between 50% and 250% of their
annual salary. The single biggest reason for employees leaving is
because of personality clashes or dissatisfaction with their
managers. It makes good business sense to hang onto your
valuable employees, even during an economic downturn. To keep
employees happy, one must understand what drives them. They
want:
1.
2.
3.
4.
5.
To be managed well.
Interesting work.
Discretion over how to do the work.
To be trained for progression or for retrenchment.
A work/life balance, i.e. they do not want to have to work
long hours – they want flexibility.
Legislation is to be published in the UK in April that will permit
employees to request flexible working hours. Employers will
have to have good reasons to refuse this request. (Page 69)
The annual reports of companies say very little about the future
plans, stated objectives, strategy or other information that is
required for evaluation of future performance. (Page 97)
Ron Paterson (I find it interesting that they publish his articles at
the back of the journal – leave the best till last) discusses the new
ED on reporting financial performance, which is designed to
combine the income statement and STRGL account into one.
Some of his criticisms are:
1.
He does not agree with presenting the unwinding of the
discount on provisions as a financing activity (me neither –
see my article in the January 2003 SA Accountancy).
2. He has problems with splitting inventory write-downs into
two categories.
3. He does not agree with the fragmentation of the postretirement employee costs.
4. He believes that the whole statement is wrong as GAAP
works on a balance sheet approach with the income statement
being the “balancing figure” and they are now trying to make
sense out of this “balancing figure”. He believes that this
statement merely highlights the flaw in the accounting
framework. (In case you do not know Ron, he believes that
the income statement should be the prime document based on
matching and prudence.) (Page 101)
The US has approved a new standard called consideration of fraud
in a financial statement audit. This is in response to restoring
investor confidence in US capital markets and in audited financial
statements. (One could argue that it is the start of the closing of
the expectation gap – something that should have been embarked
upon many years ago.) The key points of the new standard are:
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Mafia Buzz 2003
1.
2.
3.
4.
Understand the characteristics of fraud.
Brainstorm how the entity could commit material fraud.
Obtain information to assess the risk of material fraud.
Identify the risks that may result in misstatements due to
fraud.
5. Assess fraud risks in the light of the entity’s programmes and
controls
6. Respond to the fraud risk assessment.
7. Evaluate audit test results.
8. Communicate findings to management and the audit
committee and others.
9. Document the work done.
(Can you see anything new here? This is what we have always
done or should have done.) (Page 103)
Another author who has been relegated to the back of the journal
is Dr Trisha Greenhalgh. Her articles are always informative and
well written. This month she talks about giving up smoking. She
says there is only one effective way to achieve this and that is to
just give up. Stop buying the damn cancer sticks. When offered
one say: “I have given up”. There are four phases to giving up the
“dirty filthy habit” (her words, not mine!):
1. The pre-contemplative phase (no intention of changing).
2. The contemplative phase (thinking about giving up).
3. The action phase (actively trying to change).
4. The maintenance phase (changed and trying to sustain it).
She advises to wait until you really want to give up before seeking
help. She does recommend nicotine replacement or buprion.
(Page 142)
Accounting SA
Elmar Venter discusses accounting for pre-extraction costs in the
mining industry. Some problems I have with this discussion are:
1.
The prudence concept, which is mentioned twice, is no
longer a concept of GAAP.
2. The deferral of exploration costs will not be a first in GAAP.
Go to the leasing statement and you will see examples of
deferrals there.
3. I cannot understand why one would expense prospecting
costs but capitalise exploration costs under existing GAAP.
Both involve searching for knowledge. Prospecting is
searching for suitable areas and exploration is searching the
areas identified.
Elmar is correct in saying that we need a statement for the mining
industry. We needed this statement 50 years ago. My guess is
that when all the resources have been mined, we will get our first
definitive statement. (Page 2)
Glen Mouton says that there are two actions companies take when
faced with fraud: they either hush it up or they take action against
the perpetrator. He believes that companies should have a
contingency plan in place to handle fraud. The company’s ethics
policy should state that it is open and honest in all dealings,
internally and externally, valuing integrity and effort, and not
merely financial performance. There should be rules such as
restricting authority of employees to transact on the company’s
behalf, not accepting gifts from customers outside certain limits,
maintaining a duty of confidentiality to the company and clients
and reporting any suspicion of fraud to enable action to be taken.
(Page 7)
Steven Firer asks the question “What are your intellectual assets
worth?” I ask “Why do we have to try to measure everything?
Why don’t we get on with the job of creating our intellectual
assets and putting them to good use? Why do we have to try to
measure everything? What is life worth? What is love worth?
What is your wife worth?” Some things should be measured to
enable us to manage them. But any attempt to measure things like
your knowledge serves no purpose. (Page 8)
Willi Coates sets out the work that SAICA is doing to salvage the
profession’s reputation after all the accounting scandals that have
taken place overseas and in our country. (Page 13)
Annette Heiber says that poor quality data is a concern if the Basel
11 Capital Accord is to be met in four years time. 90% of banks
surveyed believe that poor management of credit risk is a real
threat to their organisations. (Page 15)
Jan Conradie and Herman Schutte have written an excellent
detailed article on the measurement of performance in
municipalities. (I would say that one of the first priorities, before
trying to measure performance, is to get a system of credit control
operative – witness the billions of unpaid debtors that the
Johannesburg Municipality had to write off recently.) (Page 17)
My article was on the accounting standard for recognising and
measuring employee pension fund costs. (Page 29)
Penelope Webb’s article was on the risk that tax advisors face and
how they try to protect themselves against actions by placing
limits on their potential liability, whether or not this will be
effective. (Page 31)
Citigroup Circular
Warren Buffett does not believe that equities are undervalued
generally. Despite three years of falling prices, which have
significantly improved the attractiveness of common stocks, he
still finds few that interest him. In his view this is testimony to the
insanity of the valuations reached during the Great Bubble.
Economist
Royal Ahold, a Netherlands company, the world’s third-largest
grocer has admitted to overstating its profits by $500 million. It
booked unearned revenue, entered into illegal transactions and
consolidated a company it did not control. (Not much of an advert
for principle based GAAP!) (2nd)
Financial Mail
Malcolm Segal of the SA Venture Capital and Private Equity
Association says that SAICA has lost sight of the fact that private
equity companies do not earn their revenues by raising capital and
giving advice but by formulating an exit strategy and selling their
holdings at a profit. It is, therefore, illogical to equity account
private equity investments. (Of course, Malcolm is right. But
whenever did GAAP try to be logical? One of the proposed
changes to AC110 is that equity account will not apply to such
investments. Hang in there Malcolm.) (14th, page 18)
Empowerment players are drawn to the asset management
industry because this is where the purchasing power sits. It is a
perfect foot in the door to commence building an empire. (This is
a terrible thought – use other people’s hard-earned money to serve
their own purposes? Another reason to DIY.) (14th, page 45)
Warren Buffett is of the opinion that derivatives are time bombs
that could bring Armageddon to the world financial system. (21st,
page 8)
Ever expanding regulation is creating an environment in which it
is difficult for entrepreneurs and SMEs to survive, let alone
flourish. The cost of compliance is high and the regulations
numerous and complex. If government is serious about promoting
business, it needs to do something about this. (Brian Goodall
MPL, leader of the DA, Gauteng) (Great to see this kind of
comment last! Maybe there IS hope for baby gaap.) (21 st, page
11)
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Mafia Buzz 2003
FM is offering an eight-week course for middle, junior and
supervisory mangers on risk, ethics and governance – cost R500.
(We need this sort of thing in RSA.) (21st, page 12)
Cytech, which was “worth” R5 million in 1999, was valued by an
auditing firm at R150 million based on projected future cash flows
when it had not achieved anything at that point. It was then
valued to R228 million in 2001 through the income statement.
The projected cash flows did not materialise so the investment was
written down, not through the income statement but directly to
reserves as they changed their basis of accounting to equity
accounting (the company had a 47% stake in Cytech). (Question:
how can one value a company that has achieved nothing – it
merely has a business plan – at R150 million? I do not believe
that the valuer asked the critical valuation question: “Exactly what
am I valuing?”) (21st, page 24)
and encouraging fraud at Enron. The feeling is that these actions
could run into billions of dollars.(17th, page 15)
Individual investors have an astounding record of buying high and
selling low. Investors piled money into stocks three years ago
when they were at all-time highs. It is suggested that one should
compare the total market capitalisation with the GNP. It usually
ranges between 40% and 80%. Just before the great crash in 1929
it was 109%. Three years ago it was 190%! Right now it is
100%. Another overall measure is that at present the S&P 500 PE
ratio based on forecast results is 17. Based on actual results it is
30. Wall Street analysts are, therefore, projecting growth in
earnings of US companies to be 76% next year! (They have to be
bullish to encourage you to part with your cash.) (17th, page 20)
Finance Week
The stock market of the next two decades will not get you to the
retirement promised land. Returns in the past 20 years came from
increased price earnings ratios and fast growing (real and
imaginary) earnings. Market historians are predicting returns of
only 10,0% p.a. (or 6,5% p.a. after inflation) for the next 20
years.) Attitudes at present are not to even think of retirement.
People are in survival mode – “stay alive, stay healthy and hang
onto your job” is all that counts at present. Americans, for the
first time in ages, have to choose between golf memberships, the
flashy car, overseas trips and education for their children. (17th,
page 48)
Vic De Klerk (I met him in Brits the other day and was impressed
by his depth of knowledge of the JSE) quotes Gerhard Loots
(whom I have known for years) of the auditing firm GKL.
Gerhard points out that if you split your interest generating
investments between you and your wife, you will not pay tax
(assuming that you are over 65) on the first R120 000 interest
received. (12th, page 34)
Pressure to perform is making management reconsider their
commitments to their employees to provide for post-retirement
benefits. With the fall in interest rates and stock prices, a massive
shortfall has accumulated in post-retirement benefit funds. The
share prices of companies such as General Motors, Ford, Delta
and American Airlines, who are particularly hard hit, have taken
major knocks. The various choices facing companies are to:
The Johannesburg city council has hauled its skeletons out of the
closet and provided for a R3,9 billion deficit – R1,5 billion
unfunded pension plan, unrecoverable debt of R1,5 billion and
“unreconcilable items” of R0,9 billion. (The time bomb is being
fused!) (21st, page 29)
Merrill Lynch believes that the Rand could be R7 to the $ by the
this time next year. (21st, page 31)
Sello Mabotja has written an interesting article on whether or not
trusts serve any purpose in this day an age. The original purpose
of trusts was to preserve wealth and attend to the wellbeing of
widows and orphans. However, trusts became the vehicle for
avoiding transfer duty and taxes and, as a result, have been
targeted by the tax authorities. He concludes that they still,
despite the tax disadvantages, have a role to fill, e.g. when the
farmer dies there will be no capital gains tax and estate duty
payable as the trust is still alive. The capital gain on the farm will
only be subjected to CGT when the trust sells the farm. Trusts
should be used for the purpose they were designed for, i.e.
succession planning and providing for beneficiaries. Most of the
tax loopholes have been closed. (19th, page 33)
The Australian stock exchange has launched listed securitised gold
bullion for investors who would like to hold gold but not have the
inconvenience of insuring, storing and handling it. (Great idea
provided the gold is there! In RSA?) (31st, page 12)
The Saccawu National Provident Fund with 60 000 members has
been placed in provisional curatorship due to a number of
irregularities that have allegedly taken place. (Keep control of
your own wealth, I tell you!) (31st, page 54)
Fortune
The US is considering abolishing the (double) tax on dividends,
which has been in operation since 1913. This will change the way
managers and investors will view their investments. (We have
been through this process in RSA) (3rd, page 13)
Since October 2000 companies in the US may not divulge
information to analysts without making a press release. This is in
terms of SEC’s regulation on fair disclosure. (Taking some of the
power away from analysts.) (3rd, page 60)
1.
2.
Dump their obligations completely.
Change the method of calculating the obligations (increase
the discount rate – don’t you love it!).
3. Slash retirement benefits.
4. Convert to defined contribution plans.
5. Retrench staff and pay them out only their contributions.
6. Do not offer new staff the benefits. (17th, page 53)
Warren Buffett says that derivatives are financial weapons of mass
destruction. The dangers are now latent but they could be lethal.
Unless derivative contracts are collateralised or guaranteed, their
ultimate value depends on the creditworthiness of the counter
parties to them. Before a penny changes hands, the counter parties
record profits and losses – often huge in amount – in their current
earnings. Bonuses are often paid based on these earnings, which
are a sham. Large amounts of risk are concentrated in the hands
of a few derivative dealers. If one goes, it could trigger a serious
systematic problem. He says that after reading the footnotes
detailing derivative activities of banks, the only thing that he
understands is that he does not understand how much risk the
institution is running. (17th, page 58)
The average worker now spends more than two hours a day
reading, responding to or disposing of e-mail. I sometimes
wonder whether I am really being effective in my job spending
half the time in e-mail, half the time on the phone and the other
half doing real work. (Note that he spends half his non-working
time working to make up the other half!) (17th, page 78)
JSE Circular
A letter from the JSE dated 27 March clarifies that it does not
endorse the results from a GAAP perspective by reviewing the
financial statements prior to publication in SENS and the press.
A federal judge in the US has declined to excuse eight investment
banks from a class action in which they are charged with enabling
8
Mafia Buzz 2003
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. (11th)
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?
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)
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)
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)
What is a Hedge Fund? Should I be Investing in One?
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
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
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)
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Mafia Buzz 2003
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 nonlisted 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)
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
10
Mafia Buzz 2003
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! (8th)
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. (25th)
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)
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 Tbills 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?) (4th, 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.) (4th, page 79)
The ex-CFO of WorldCom has been indicted on a further 11
chargers that carry jail terms of up to 120 years. (25th, page 8)
Citizen
Finance Week
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.) (8th)
It is estimated that almost 70% of retirement funds in SA are now
DC funds and many members are not aware that they are in charge
of their own investments. Lorette du Toit has the following advice
for such members:
Financial Analysts Journal
2.
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)
3.
4.
1.
Contribute as much as possible. (Got to be kidding! See this
fund as a lost cause. DIY.)
Preserve your retirement assets by never withdrawing
benefits. (Take your money and run!)
Lobby for costs to be kept low.
Choose the right option.
11
Mafia Buzz 2003
5.

Draw a vertical line. Call the top “Active” and the bottom
“Passive”. Cross the vertical line with a horizontal line. Call the
left “Positive” and the right “Negative”). Leaders can be
described by these characteristics, e.g. Jimmy Carter was
active/negative, Lyndon Johnson and Richard Nixon were
negative/passive, Ronald Reagan was positive/passive and George
Bush is active/positive. (16th, page 16)
Managers, who after all are just hired hands, start behaving as if
they own the place. Owners, mostly unit trusts and pension funds,
behave as if they do not own the place – in fact they vote in
accordance with the directions given by the managers of the
companies they own! Until the owners start taking control, the
pigs will be running the farm. (28th, page 27)
Save as soon as possible to all the power of compound
interest to kick in. (I agree, but DIY!)
(I was stupid enough to invest for about 20 years in a RAF. Every
year it cost me a day to get a certificate for tax purposes – without
the certificate, no deduction – they never sent me one so I had to
go into town to get it. One year I went to get my certificate only
to find that the company had disappeared. At least this investment
loss I made was tax deductible!) (9th, page 38)
Vic de Klerk tries to explain how a FRA (forward rate agreement)
works. He gives an example where for one year you can earn 11%
p.a. and for two years 10% p.a. He says that the effective second
year rate is 9% ((11% + 9%)/2). This is not correct. The second
rate is actually 8,11% p.a. (1,11x1,0811 = 1,20). (16th, Page 41)
Bayer and GlaxoSmithKline were fined $258 million by the US
Attorney’s office for allegedly defrauding the US healthcare
provider Medicaid. (23rd, page 6)
The top six firms world wide by revenue are PwC, D&T, KPMG,
E&Y, Grant Thornton and BDO, in that order. PwC’s revenue
was R1,6 billion and BDO’s R125 million. (23 rd, page 11)
Shaun Harris believes that investors should start nibbling at
equities as he feels that the market is under-valued at present. He
suggests phasing money in slowly “until the outcome for equities
is more clear”. (When is the outcome ever clear?) (23 rd, page 42)
Fortune
Prof. Paul Miller, accounting professor at University of Colorado:
“Management believed the market was valuing companies based
on a multiple of their revenues so they thought ‘Aha’ all we have
to do is to get our reported revenue up and we will have a higher
stock price. It worked for a while but eventually the market
caught on.” (How the market fell for this in the first place is a
wonder!) (14th, page 86)
In 2002 AOL Time Warner announced write-offs totalling $98,7
billion, beating the record of $56,1 billion set by JDS Uniphase in
2001. Other goodwill and intangible asset write-offs in 2002 were
$40 billion (Quest), $11 billion (Clear Channel) and $6 billion
(SFX Entertainment). (14th, page 86)
The top companies in the US based on revenue for 2002 were
Wal-Mart Stores, General Motors, Exxon Mobile, Ford Motor,
General Electric, Citigroup, Chevrontexaco, IBM, American
International Group and Verizon Communications. The top ten
when ranked by market capitalisation are Microsoft, General
Electric, Exxon Mobil, Wal-Mart Stores, Pfizer, Citigroup,
Johnson & Johnson, IBM, American International Group and
Merck. (14th)
CEOs give themselves piggy pay packages. An example is
Honeywell’s CEO who received a base salary of $1,5 million, a
bonus of $1,9 million, make-whole payments of $2,7 million,
other payments of 0,9 million and restricted stock and options of
$61,5 million. (Now you understand the push for accounting for
share based payments!). (28th, page 25)
When Congress legislated against CEO pay abused, the Law of
Unintended Compensation kicked in, e.g.:

They imposed an excise tax on payments above 2,99 times
the base salary – companies made 2,99 the new minimum
and covered any excise tax.
They tried to shame CEOs by requiring better disclosure of
their pay – CEOs could now see how much others were
earning so they tried to beat the other guy.

They declared salaries of over $1 million to be non-tax
deductible – salaries were increased to $1 million and huge
stock option grants were given.
With reference to pay packages: “The more troughs a pig feeds
from, the fatter it gets!” (28th, page 25)
Retirement pay in the form of SERPs is stealth-compensation hardly anyone knows about it. This compensation takes the form
of a percentage of an employee’s pay every year to produce a
guaranteed payout on retirement. It is offered by half of public
companies to their top dozen or so officers. Due to collapsing
stock markets and low interest rates, about 40% of companies are
seriously considering cutting pension benefits to ordinary staff.
However, SERP give-aways are actually on the increase. This
compensation applies even if the executives are fired. (28th, page
31)
AOL Time Warner’s CEO certified the company’s financial
statements except for $49 million in revenue. After investigation,
this figure has now climbed to $190 million with another $400
million suspect. This, of course, impacts on the bottom line as
well. The company has acknowledged that further re-statements
might become necessary. (28th, page 57)
Techtalk
SAICA apologises for the “printing error” that appeared in the
headline circular. (I am sorry but it is a shambles!)
May 2003 (30 Minutes)
Accountancy
The UK government is to consult during the “summer” on
increasing the audit threshold to ₤4,8 million. (Why do northernhemisphere commentators have to refer to time by seasons?
Maybe they are ignorant of the fact that the seasons are different
between the Northern and Southern hemispheres!) (Page 17)
Andrew Oswald says that the UK government should work on the
small stuff such as fixing public toilets and improving garbage
collection and forget about the big stuff. (They could look to RSA
for some excellent examples of groundwork improvements, e.g.
taps in rural areas with clean water, which make a major impact
on the quality of life of people.) (Page 28)
Donald Gordon (CA) (SA) (yes, our very own), chairman of
Liberty International, lambasted the Higgs’ proposal that a chief
executive should not go on to become chairman of the company as
“palpably absurd and unhelpful”. He said that the bulk of Higgs’
recommendations “give no primacy to business judgement”.
(That’s telling them Donny – rules can’t stop dishonesty!) (Page
37)
Higgs says that SOX risks dividing the board into two camps –
those who run the business and those who are there to stop them
from stealing the sweeties. (Page 37)
The SOX Act in the US prevents audit firms from performing
internal audit work for external audit clients because of the
potential conflict of interests. This affects clients globally that are
registered with SEC. Audit committees should think carefully
12
Mafia Buzz 2003
about this conflict when outsourcing internal audit work. (Page
45)
Investment fraud in the UK has risen from ₤244 million in 2001 to
₤717 million in 2002. There are usually two types of fraud:
1. Where you are promised fantastic high yielding investments.
2. Where you pay an advanced fee from some future service.
It is estimated that $100 billion is defrauded world wide using the
advanced fee fraud. These frauds have one thing in common –
they never come to fruition. (You do not need a checklist to avoid
being taken for a ride. Use one simple principle: keep in control
of your own investments – DIY. And remember that if it is too
good to be true, it is.) (Page 52)
A UK government taskforce is looking at ways to account for
human capital in the annual report. (Tried before and failed. Why
do you have to account for everything? Why not have a special
report in the AFS about your most valuable asset setting out things
like training, staff turnover, numbers promoted during the year
and, in RSA, a race and sex break-down.) (Page 53)
“I decided to show new products separately so that any potential
buyer could quickly see what organic growth was deliverable from
the current range without factoring any of these new products into
account.” (Now that is valuable user information!) (Page 55)
Moira Hindson of Kingston Smith discusses a “difficult client”
case study and what lessons to learn from such an experience. Her
description of a difficult client is one that has poor record keeping,
places a low priority on financial matters, is not interested in
formalities such as engagement letters, will not supply the
accountant with basic information, is behind on its tax (need I go
on?), etc.) She sets out a checklist of steps to take in such cases
such as:
1. Get a signed engagement letter.
2. Send a checklist of documents needed for the assignment.
3. Give, in writing, action to be taken to rectify tax problems.
4. Document actions taken to get information.
5. Bill for fees on a regular basis.
6. If the client does not comply with the requirements, resign.
(Page 68)
Profits have fallen for 14 quarters in a row in the UK. The
average return on capital is now 7% p.a. (Page 71)
Executives around the world are still uncertain about what the new
IFRS standards will entail and how large and wide-ranging the
changes will be. (Join the club.) (Page 89)
Clive Jones asks the question: What is the point of increasing the
amount of information companies have to place on the public
record (in the UK) if at the same time by raising the audit
threshold the quality of that information falls significantly? (Page
92)
Mark Hutchinson asks whether one would take advice from an
independent financial advisor who gets commission from the
company whose product he recommends. (Got news for you
Mark: it happens all the time!) He then goes on to ask why a
company should take advice from an auditor on how to organise
itself. He suggests a regulated break-up of the industry to enable
greater competition and expertise to develop. (I wonder if he has
a personal bodyguard?) (Page 93)
The UK is anticipating the cost of converting to IFRS: staff
training, updating systems, etc. (The UK will take much pain as
they have done their own thing in the past and will in one year
have to do a complete changeover.) (Page 94)
If a company is part of a group of companies and its staff
contribute to a group defined benefit plan, how does one account
for any surplus or shortfall in the group plan in the books of the
individual company?
One cannot treat this as a defined
contribution plan in the books of the company. The pension fund
costs, income, surplus or deficit would have to be apportioned to
the various companies in the group. (Page 96)
Peter Whyman, president of the ICAEW, makes the following
points about the Higgs proposals:
1.
2.
He believes that 95% of the proposals are not controversial.
He feels that it should be based on a “comply or explain”
basis.
3. He believes that principles encourage compliance whereas
rules encourage avoidance (in my opinion this is a fallacy!).
4. He feels that there should be fewer provisions and more
principles.
5. He believes that it is the world’s best corporate governance
model (he is obviously unaware of our King 2 report!) (Page
132)
Dr Trisha Greenhalgh writes that if you are thinking of dying you
should have a plan.
1.
2.
Get a rough idea of how long you have got to go.
Decide on whether or not to enter into a living will, i.e.
instructions on what to do if you are not capable of taking
decisions towards the end.
3. Get your paper work in order (will, insurance policies, books
up to date, etc.).
4. Give instructions to whoever is going to wind up the estate.
5. Decide on what you want done with your body – buried,
cremated, donated or recycled (what?).
6. Prepare for whom you are going to meet at the other side
(improve your store of good jokes).
7. Set aside time to say your goodbyes to the people close to
you. (This woman should have been an accountant, not a
medical doctor!) (Page 138)
Thinking of buying a property? Here is a checklist for you:
1.
2.
3.
4.
5.
6.
7.
8.
9.
Buy in the right area.
Get the right financing.
Have a maintenance plan.
Keep a reserve fund for unexpected surprises.
Decide on who is to manage (keep an eye on) the property.
Make the tenant sign a lease agreement.
Get proper insurance cover.
Sort out the tax implications – losses allowed, CGT, etc.
Get the tenant to sign a detailed inventory of the contents
before moving in.
10. Get a deposit from the tenant to protect yourself from
damages or rental payment defaults.
(And from my experience, visit the potential tenant’s present
abode to assess the tenant’s lifestyle, check the financial
statements of the body corporate to ensure that it is not insolvent,
check the security arrangements and study the resident rules and
enquire whether they are enforced.) (Page 139)
Accountancy SA
Mike van Wyk takes a critical look at what can be in store for the
profession if the Accountancy Professions’ Act incorporates some
of the draconian conditions in the SOX Act. He makes a plea to
you to get involved in commenting on the bill but holds out little
hope that your submissions will be taken into account. (This is
par for the course in our profession! Just look at how 3 500
submissions were ignored in the differential accounting document
that was recently published by SAICA.) (Page 2)
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Mafia Buzz 2003
Mike Savage says that only one third of staff of companies feel
that the use of company hardware or software or the Internet
amounts to fraud. (Page 6)
Wilna Steyn and Pieter von Wielligh ask the question: “Can we
rely on cash flow statements?” They answer their own question
by giving evidence that cash flow statements cannot be relied on.
(From my personal experience, very few accountants understand
the cash flow statement and, to be quite brutal, neither do the users
of the financial statements. The old source and application of
funds statement was easy to prepare and far more effective as a
user document.) (Page 16)
Beric Croome says that the RSC and SETAs do not have the right
to access of the books of companies. (Why even raise the issue?
What have you got to hide? I would not object to them checking
my books because I pay my levies in full each month. My only
problem would be the time wasted.) (Page 19)
My article was about trying to get a ruling on a matter from the
standard setters – do not bother to try! (Page 27)
Penelope Webb relates some interesting stories on tax fraud in her
article. (Page 31)
Business Day
The auditing profession is dead against the rotation of audit firms.
(One must agree that to rotate auditors for the sake of rotating is
really dumb.) (6th)
CFA Digest
The three steps to developing, implementing and maintaining an
appropriate portfolio are:
1.
Asset allocation (deliver the right exposures and level of
risk).
2. Purchasing and maintaining reasonably priced representative
securities.
3. Verification that the agreed-upon strategy and return are
being achieved.
(Instead of focusing only on risks at the allocation stage, should
also focus on return.) (Vol. 33, No. 2, page 54)
Myron Scholes says that shares are not unique works of art but
abstract rights to an uncertain income stream. (Investors forgot
this simple concept during the IT boom.) (Vol. 33, No. 2, page 54)
There is empirical evidence that investments in mutual funds were
eight times higher after a bull market than after a bear market.
(Greed and emotion govern decisions.) (Vol. 33, No. 2, page 69)
Investor’s tax-sheltered assets are typically valued before
deducting taxes. If these assets are to be converted into future
retirement income, after-tax values are more appropriate. (Don’t
invest in retirement annuities just because they are tax-free: you
pay the piper at the end of the day!) (Vol. 33, No. 2, page 81)
Not re-balancing portfolios because of the tax implications could
result in sub-optimal portfolio performance. (Vol. 33, No. 2, page
86)
CFA Magazine
During the 1990s, only 2% of recommendations made by sell-side
analysts were to sell the stocks due to pressure put on them by the
issuers of the stock. (January, page 5)
Some investment advice from the investment gurus:
1.
Making wealth is not the answer to human progress or
happiness.
Spiritual progress is the answer. (John
Templeton) (An investment or spiritual guru?)
2.
The unthinkable can always happen and you have to run your
affairs accordingly. Survival in this game begins with
humility. (Peter Bernstein)
3. Look at every stock as part of a business rather than things
that go up and down. Have the right attitude to fluctuations.
Build a margin of safety into what you pay. Prosper from the
actions of the business rather than from the actions of the
stock over the short term. The Investment Professionals
Industry is the only industry I know where the professional’s
efforts subtract value from what the layman can do himself.
(Don’t you just love this man?) (Warren Buffett)
4. Focus on long term investment and not on short-term
speculation. Base the assessment on a steady, sophisticated
enlightened, analytical approach rather than on the public
appraisal of the price of the share.(Jack Bogle)
5. Develop your skill set, work at it, hone it and do not follow
the crowd. (Gary Brinson)
6. Develop and stick to your own style. (Dean LeBaron)
(January, page 20)
The most common financial shenanigans according to “How to
Detect Accounting Gimmicks and Fraud in Financial Reports” are:
1. Recording revenue too soon.
2. Recording bogus revenue.
3. Boosting income with one-time gains.
4. Shifting current expenses to a later or earlier period.
5. Failing to disclose all liabilities.
6. Shifting current income to a later period.
7. Shifting future expenses into the current period.
(They should come over to RSA – we can show them a thing or
two!) (January, page 45)
To provide clients with accurate, high-quality, independent
research, investment analysts must be free of undue influence.
Here is what goes on:
1.
After analysts lower their view of stock, companies ignored
these analysts during conference calls.
2. Companies put pressure on analysts through their bosses.
3. Some companies threaten analysts with court action if their
stocks are downgraded. (March, page 2)
The SOX Act bans the following non-audit services by the
external auditor:
1.
2.
3.
4.
5.
6.
7.
8.
9.
Bookkeeping services.
Financial system design and implementation.
Valuation of assets and liabilities.
Actuarial services.
Internal audit.
Management services.
Brokering, investment advising and investment banking.
Most legal services.
Expert opinions that support interests in litigation or
administrative proceedings.
Auditors can still give tax advice. (March page 18)
Under pressure to meet earnings targets, maintain market
capitalisation or retain access to financial markets, companies
often resorted to non-GAAP financial measures. A popular one
was called “pro-forma earnings” or “earnings before the bad stuff”
such as depreciation, amortisation, asset write-downs,
restructuring charges, etc. The SOX Act now requires disclosure
of a reconciliation between these measures and the GAAP
numbers. (March, page 24)
The Financial Accounting Policy Committee believes that in the
setting of accounting standards a balance must be struck between
broad principles and the inclusion of sufficient interpretation and
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Mafia Buzz 2003
implementation guidance (rules), which is necessary to ensure that
the intent and spirit of the principles are clear. (Agree!) (March,
page 24)
The Indiana University found that the following ratios showed
promise in revealing the possibility of cooked books:
1. Sales growth.
2. Gross margin.
3. General and administration expenses to sales.
4. Debt to equity.
5. Level of receivables.
6. Level of inventories.
7. Depreciation to cost of assets.
8. Total accruals to total assets. (March, page 32)
Wall Street firms don’t make money by selling research – they
make it in investment banking. So one can foresee more
independent research firms getting a slice of this business in the
future. (March, page 35)
We do not engage in the typical quantitative research of running
thousands of back tests and, if you see a relationship, that’s the
model. That approach is likely to fail in the real world. We try to
make certain that our models all derive from fundamental casual
investment relationships. (March, page 39)
The IASB is working on proposals together with the UK standard
setting body, the ASB, to capitalise leases. David Tweedie says:
“Wait for the squeals when it (the exposure draft) comes out.”
(March, 2003)
Citizen
“I must warn the public, the general auditing community and
SARS officials that corruption destroys lives. Look at me.”
(Grant Ramsay on his way to chookie.) (10th)
Fund managers can’t make money for unit trust investors because
of the excessive buying and selling of shares, which chops several
percents off returns. (Anthony Ginsberg) (A buy and hold strategy
invariably beats a churn strategy. Investment managers need to
churn to generate fees.) (29th)
Financial Mail
The pension fund surplus regulations have been published and are
still causing confusion. Lawyers and actuaries stand to make a
packet out of this confusion, as always, at the expense of the poor
members of the post-retirement benefit funds. Some points of
interest:
1.
If a fund can show the FSB that it does not have a surplus, it
will not have to go through the apportionment exercise.
(Actuaries just have to reduce their discount rate to get rid of
any surplus.)
2.
Former members who belonged to a fund on or after 1
January 1980 must register with their former funds to be
eligible for a payout.
3.
Surpluses may not be used to fund pensioners’ medical aid.
4.
Defined contribution funds will have to do the apportionment
exercise even though the fund rules dictate that the assets and
liabilities must be matched at all times. (More money for the
actuaries and less for the members.)
5.
Minimum withdrawal benefits from defined benefit funds,
the cause of the problem in the past, have now been set. (I
find it fascinating that they can use a discount rate of 40% of
the earnings yield of the JSE – I wonder if they know what an
earnings yield is!)
Warren Buffett says that investors are dreaming if they think they
will get the 15% p.a. returns from equities they used to get. He
says that they should get used to returns of 6% to 7% p.a. (This is
in the US. In the RSA: 9% to 12%?) (23rd, page 52)
The morning after the latest suicide bombings in Saudi Arabia
President Bush was quoted as saying: “We will track down the
despicable killers who carried out the suicide bombings – they will
learn the meaning of American justice.” (Makes you think!)
(23rd, page 74)
The JSE regulations now require the offices of the chairman and
the CEO to be separated. (30th, page 8)
The Companies Act is in the process of being redrafted and we
can expect the process to take between three and five years to
complete. (30th, page 17)
Stephen Koseff (CEO of Investec) believes that it could take
between four and five years before the equity markets recover.
(30th, page 42)
Sekunjalo alleges that Deloitte did not prepare the financial
statements of LeisureNet in accordance with GAAP. (Could
someone please explain to Sekunjalo that auditors do not prepare
financial statements – they audit them!) (30th, page 44)
The average balanced portfolio in the Alexander Forbes global
Large Manger Watch has provided a return of 5,6% p.a. over the
past three years. (Why do actuaries persist in discounting pension
fund obligations at 5% p.a. above the inflation rate and why do
standard setters insist on using government bond rates (currently
9% p.a.). Companies are grossly understating their pension fund
obligations and no one seems to be able to see this (or they are
purposely shutting their eyes to it). History will show that this
was the largest all-time accounting fraud perpetrated on
employees and investors.) (30th, page 59)
Finance Week
Jack Milne has at last come clean. Anyone who had listened to his
feeble stories on the Alec Hogg show in the past would have been
able to see right through him. The editor has called for legislation
to guard against people like him in the future. (26th, page 4)
Vic de Klerk tells the awful story about an asset manager of the
Joint Municipal Pension Fund who lost R1,3 billion of the fund’s
assets by speculating in maize futures, i.e. R500 000 per member.
Any first year CFA (not the other one) can tell you that
agricultural futures are not the kind of “investments” pension
funds should be making. The trustees are clearly responsible for
the allocation of investments and should be held responsible for
this. If it can be shown that the asset manager was not given
permission to speculate, the asset manager and his employer
should be held responsible. (Give someone else your money to
manage and you can kiss it goodbye. I was chatting to a trustee of
a listed company’s DC pension fund the other day and he told me
that they lost R200 million of the fund’s assets as a result of
speculating in financial derivatives! This amount will probably be
hidden in the investment income of the fund. Who monitors the
trustees?) (25th, page 12)
Mr Deon Basson objects to Corpcapital’s (CRP) accounting for its
47,5% holding in Cytech (C). CRP re-valued its investment in C
and credited income, including the amount in headline earnings.
When C’s valuation did not materialise, CRP changed its
classification of C to an associate and impaired the value of C
outside headline earnings. Mr Basson maintains that this was a
change in accounting policy. It was not a change in accounting
policy. Previously CRP did not have significant influence in C.
On acquiring significant influence, the classification change was
made. I know that the whole thing stinks but do not blame the
fiasco on non-compliance with GAAP, thereby implicating the
auditors. If anyone should take the blame it should be the
standard setters who permit revaluations of capital assets such as
Cytech to be included in headline earnings. (28th, page 37)
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Mafia Buzz 2003
Fortune
Who wants to be a director of a listed company with angry
shareholders and aggressive regulators breathing down your neck?
1.
Analysts focus on quarterly earnings and fail to grasp the
company's long term strategies.
2. Accounting costs are increasing due to the new requirements.
3. Audit costs are increasing because of the greater risks the
auditors now face.
4. You now have to take strangers onto your board and insure
them against potential liabilities. (26th, page 11)
After the scandal broke about investment bankers punting their
client’s shares, analysts started asking the question: “Is this
company a client of yours?” What analysts did not realise was
that some investment bankers were being paid to give favourable
reports by other investment bankers! (When will the deceit ever
stop?) (26th, page 17)
After Tyco’s spectacular deceptions, its new management
announced a microscopic inspection of the books and declared all
problems found. Then it went to the public markets for a major
debt refinancing. Then – oops! – it announced newly found
accounting errors requiring a $1,1 billion charge to earnings. (26th,
page 17)
over time because they don’t have a base from which to operate.
Everything we do is rational. We make mistakes, but we operate
rationally and that will take you a long way. (Warren Buffett
referring to his investment bible called “The Intelligent Investor”
by Ben Graham.) (18th)
Taxgram
In ITC 1745 an auditor valued a company at R190 000, being the
net asset value, for donations tax purposes. SARS placed a value
on the company at R1 440 500. The taxpayer admitted that the
fair market value of the shares was clearly above R190 000. The
auditor’s valuation was clearly not reflective of the fair market
value of the shares. The auditor was hoping to go for the lowest
valuation possible that SARS would, hopefully, accept. (Do not
play games like this! An auditor is supposed to have integrity and
be independent. SARS does not employ fools. The PAAB needs
to make an example of this auditor, especially in the light of the
potential problems we are facing with CGT.) (Issue 4, May 2003,
page 11)
Time
The US division of Ahold, the Dutch grocery company, overstated
its profits by $880 million, 76% higher than initial estimates of the
fraud. (19th, page 16)
HealthSouth displayed all the red flags for the auditors to see:


A large increase in profits with flat revenues
Management with large stock options riding on next quarter’s
numbers

A CEO with a history of playing fast and loose

An email tip alleging fraud
One must ask: “How did the auditors miss a $2,5 billion
accounting fraud?” (26th, page 38)
E&Y is investing heavily in the training of its staff on the new
accounting pronouncements, internal controls and financial
reporting quality. It is also focusing on its annual “acceptance and
continuance” decisions, i.e. whether it will continue to work for a
client or walk away because of doubts about management’s
integrity and other risks. (26th, page 38)
After the disasters at Enron, Kmart, and Global Crossing where
consultants were heavily involved, questions are being asked
about the rationale for paying fees of up to $5 000 a day per
partner for their so-called wisdom. Clients are looking for small
nimble teams of seasoned people who have years of knowledge
and experience and not for lofty thinking and giant buzzword
filled reports telling executives what they should already know.
(26th, page 50)
Ted Turner, who had over 90% of his enormous wealth tied up in
AOL and who is now down to his last $1 billion says: “No one
should ever concentrate wealth like that, particularly where they
don’t have control”. He goes on to say: “You should set goals
beyond your reach so you always have something to live for. You
never have enough time in life. I am constantly battling to stay
ahead. I say to myself: All you have to do is to put one foot in
front of the other and just keep walking.” (My personal mantra
when I feel overwhelmed is to repeat: “Do one thing at a time –
think, plan and focus full concentrated energy.” (26th, page 61)
Stanley Bing asks the question: Why should the regulators get the
massive penalties that are being charged to the companies for their
actions? Should this cash not be given to those who lost as a
result of management’s actions? (26th, page 88)
Sunday Times
There are all kinds of people with high IQs in the investment
business and most of them flame out. They don’t do that well
June 2003 (30 Minutes)
Accountancy
When I received my latest pension fund statement showing that its
value is now less than the total payments made into it, I realised
that I would have been better off storing banknotes under the bed.
(Editor, page 1)
ICAEW members may be subject to mandatory continuing
professional development (CDP) if their Council has its way.
(Don’t let them do this to you guys!) (Page 6)
The IASB’s controversial project on share based payments has
received a surprising amount of support following the 236
comment letters on the exposure draft. (This support should be
subject to an external audit!) (Page 10)
The SHAC animal rights protest group has threatened to target any
auditor that does the audit of Huntingdon Life Sciences company.
(Who wants to be an auditor?) (Page 17)
Chris Swinson warns against using market values in financial
statements. He states that markets are, at times, dysfunctional and
the prices in these markets are often not reliable. (One day we
will go back to historical costing – fair value accounting as a basis
for allocating costs and income to the correct periods is totally
illogical.) (Page 28)
This issue focuses on the revolt against management
remuneration; especially when there is a negative correlation
between it and the company’s performance. A study in the UK
showed that remuneration increased by 17% p.a. during the period
that the FTSE100 dropped from 7000 to 4000. The call is for the
incentive portion of management remuneration to be based on
performance. (Page 31)
The PCAOB is now up and running and the UK profession is not
terribly happy about the prospect of hoards of American
inspectors flying over to investigate UK firms who do audits of
US companies and their subsidiaries. The costs of such
inspections could have the effect that any profit generated from
the audits will be dissipated. Either audit fees would have to be
increased (to the detriment of the economy) or auditors will have
to resign. The UK is pushing for its own reviews to be accepted
by the US regulators but do not seem to be winning. (Page 36)
16
Mafia Buzz 2003
Proposed changes to the Higgs Code have been abandoned in
favour of more consultation. A working group has been set up to
produce a draft of proposed changes. (It is good to see the
consultative process that goes on in the UK and the fact that the
constituency’s views are taken into account.) (Page 38)
per employee per week to Internet and email abuse. The annual
cost to UK business is in the region of ₤15bn p.a. (Page 84)
“The notorious stealth tax on pension funds in 1997 has taken
₤5bn a year out of your pension funds. That adds up to around
₤30bn already.” (Sound familiar?) Gordon Brown’s raid on
pension funds has had the effect of reducing the value of millions
of people’s pensions and endowments and has made it more costly
for companies to provide for its employees. (Page 42)
1.
2.
3.
4.
5.
The new president of the ICAEW, David Illingworth, says that
members have to stand up and say: “We have got a brand. We
have ethics imbued in us, we have a code, we have objectivity,
judgement, integrity and talk straight.”
He believes that
international accounting standards should be introduced speedily
but that they should be sensible and understandable (a big ask!).
(Page 72)
Peter Wyman says that there is a real risk that audit firms will
abandon clients in high-risk sectors. Due to the litigious nature of
society, and the fact that there are now only four big firms,
commercial insurance cover is not available. The big firms are
considering whether it is worth it to take the risks. (Who wants to
be an auditor?) (Page 73)
Moria Hindson gives two case studies where auditors were found
to be negligent:
1.
A company’s usual monthly sales journal was a page and a
half long. In the last month of the year, it was eight pages
long. In the first three months of the following year it was
six lines in total. The auditor, who followed meticulously a
recognised audit programme missed or closed his eyes to the
fact that the company had moved its cut-off point. (I thought
that analytical review was an audit procedure?)
2.
A company factored its debtors. It created false invoices and
raised money on these invoices from the factoring company.
When the outstanding debtors reached nine months (from a
previous norm of three months) the factoring company
contacted some of the debtors to identify the problem only to
discover that they were fictitious. The auditor had enquired
about this problem but was fobbed off by management. They
never bothered to do their own investigation. (I thought that
confirming debtors is standard audit practice.)
MH gives a checklist of some basic things to look for when doing
an audit (second year varsity stuff but I give it here as a gentle
reminder):

Management representations are supportive, not primary
evidence.

Get evidence for journal entries.

Verify and reconcile inventories.

Use a practical method to confirm debtors’ balances.

Reconcile VAT returns to sales and expenses.

Do not get too familiar with management.

Be sceptical, especially with management. (Page 74)
The integrity of the banks, brokers and financial advisers is critical
to the efficient functioning of the markets. However, motivated
by greed, the banks have, in the past, published research favouring
their corporate clients. Research must be independent for an
investor to be able to rely on it. The US has protections in place
whereas the UK relies on the integrity of the market operators.
The US, therefore, provides a much better investment environment
than does the UK. (Page 80)
A survey done by the Cranfield School of Management found that
61% of UK SMEs are losing an average of two hours productivity
The loss of a laptop can be devastating. Some tips to protect it
are:
Use a lock to secure it to your desk while in the office.
Secure it to an immovable object when at home or in a hotel.
Avoid obvious laptop carrying cases.
Don’t disengage the internal password or firewall.
Engrave your name and telephone number on it (does not
work in South Africa!).
6. Keep a record of the description and serial number.
7. Regularly backup the data and keep the backups safe. (Page
86)
With opposition to the principle of expensing stock options
decreasing, the focus is now moving towards measuring the cost.
(Page 91)
The IAASB has ruled that when financial statements are prepared
using IFRS, an unqualified audit report is only possible if the
financial statements fully comply. A reconciliation of the results
to IFRS does not achieve compliance with IFRS. It is unlikely
that one set of financial statements can comply with IFRS and the
national accounting framework. (Page 92)
The following proposed statements published by the IAASB can
be downloaded from www.ifac.org:
1.
2.
International framework for assurance engagements.
Assurance engagements on subject matters other than
historical cost financial information. (Page 92)
The ASB has published a discussion paper on accounting for notfor-profit organisations. It can be accessed at www.asb.org.uk.
(Page 94)
Accountancy SA
Martin Prozesky advocates teaching ethics at university. (I have
been calling for this for the last 20 years but no one listened. In
the 35 years I prepared candidates for the Q.E. I could count the
number of ethical questions in the Q.E. on one hand. You try to
teach someone a topic that they know will not be asked in the Q.E.
In the CFA examinations approximately 20% of the marks are
awarded for ethics.) (Page 2)
Alison White sets out the proposals for business combinations (no
more goodwill amortisation, no more negative goodwill, detailed
guidance on reverse take-overs and tightening up on provisions on
acquisitions and subsequent changes. (Page 10)
Graeme Tosen deals with the tainting provisions where a company
classifies a financial instrument as a held-to-maturity financial
asset. (Page 13)
My article was about a nightmare financial advisor. (Page 23)
A UK commentator made the comment I made in the “Just
Pondering” letter in the March journal. It was not my idea. The
editor never gave me an opportunity to answer the letter criticising
my comment. Willi Coates on the same page was given this
opportunity. Why not me? (Page 25)
Business Day
SAICA has published a discussion paper on contingency fees.
Ethically, they believe that such fees should not be charged. The
banning of contingency fees could result in a loss of work to nonqualified accountants because they will not be subjected to the
same rules as us. (10th)
Risk management is management’s responsibility. They should:
1.
Understand the risks to the company’s assets.
17
Mafia Buzz 2003
2. Establish the vulnerability of the company to these risks.
3. Measure the potential effect of risk.
4. Assess controls in place to mitigate the risks.
5. Decide whether to accept, mitigate or transfer those risks.
6. Develop and implement a risk management strategy. (19th)
Only 20% of black candidates passed part 1 of the QE (overall
pass rate 45%). SAICA says that they will have to raise more
money to throw at the problem. (I wonder if they have done a
detailed study of the causes of the problem. Money won’t help.
They need to get to the bottom of the problem before throwing
money at it. I know what the problem is and have tried to tell
SAICA but they will not listen.) (23rd)
A newly created pension fund of Transnet is already in trouble and
ways and means of propping it up are being considered, e.g. the
issue of a bond. Pensioners have called on the public protector to
investigate the state of the fund amid claims that it has sustained
losses of R4bn in the past two years. (Again, they are not getting
down to the cause of the problem and rectifying the cause. The
trustees guaranteed returns of 16,5% on assets. Are they out of
their minds? Who is advising these people?) (27th)
A taxpayer may only use the valuation method for the tax base for
capital gains tax purposes if a valuation is done within two years
of 1 October 2001. If such a value is not done, one of the other
two methods will have to be used when the asset is “sold”. (30th)
Citizen
The FSB is suing Deutcsche Securities for R54 million for insider
trading. (Be careful what you do with inside information. Mr.
Barrow is serious about this misdeed.) (7th)
According to a study done by Harvard, sell-side analysts talk up
share prices where they are involved with the company. (Do your
own research when taking investment decisions.) (7th)
Andrew Kenny, who has just turned 55, has the following to say
regarding the lessons he has learned about money (read this
carefully!): “I have allowed various insurance salesmen to make
an idiot of me. If I had managed my money better over the last 30
years I would be facing the prospect of a comfortable retirement
rather than a precarious one. When I realised what a con my
disastrous retirement annuity was I stopped paying in. The
insurance company deducted an enormous fee. What is left over
has been shrinking ever since. I have lost money on endowment
policies, unit trusts and managed investments. It is always the
same story: warm smiles to get you to pay your money in and icy
contempt when your investment matures and you find that you’ve
lost half of it. The lesson I have learnt is to manage your own
investments. Pay off your house as soon as you can.” (Shortened)
(10th)
Financial Mail
Dutch retailer Ahold, which earlier revealed $880 million in
overstated earnings, says it has found further intentional
accounting irregularities. (6th, page 8)
A London high court judge ruled that Deloitte and Touche was
negligent in auditing Barings Bank and is liable for damages.
(20th, page 8)
Maxiprest pays SARS R42,6 million iro tax frauds resulting from
advice given by Mr Grant Ramsay. (How many more companies
are we going to read about? 399?) (27th, Page 8)
General Motors is to raise $10 billion to plug a $19 billion pension
fund hole. (And the other $9 billion?) (27th, page 8)
If we want to attract foreign investment to our country, we should
make the environment attractive to the investors and not to the
employees. (Letter to editor, 27th, page 10)
The JSE does not give up easily: after failing with its development
capital market and its venture capital market, it is trying again
under a new banner: ALTx. This Alternative Exchange is
designed to promote small, medium BEE enterprises. (Good luck.
At my age and risk profile, count me out!) (27th, page 12)
The FM has published its list of top companies. It is based 40%
on actual past performance and 60% on the view of the FM. The
top 20 are, in order, Impala, Sasol, Pick ‘n Pay, African Bank,
Anglo Platinum, MTN, Harmony, Sappi, Energy Africa, Mr.
Price, Reunert, Delta, Afrox Health, Chemserve, BHP Billiton,
Trnashex, Ceramic Industires, Oceana, Altech, and ABI. From 1
March 2003 to 11 July this portfolio is making a loss of 7,2%
compared to a market gain of 5,2%! (27 th, page 46)
Finance Week
Ethics should be an essential component of the syllabus at varsity
for every discipline. The emphasis must be on what is right rather
than teaching the bare necessities. (4th, page 32)
Preference shares should be considered as part of the portfolio of a
retiree once the tax on interest kicks in. (4th, page 47)
Mr Mike Lomas, CEO of Group 5, says that the establishment
costs of the expanded Everite factory are being amortised over
five to 15 years. (I thought that establishment costs couldn’t be
capitalised in terms of the statement on intangible assets. An
investigation is needed by the JSE into this matter. Maybe they
are just using the wrong terminology. I do not have the financials
so cannot check.) (11th, page 10)
Deon Basson says that Group 5’s establishment costs should not
have been capitalised (see the previous info-byte). He states that
R63 million is shown on the balance sheet as deferred closure
costs! (If this is true, then Group 5’s managers have some
explaining to do.) (11th, page 42)
Should one allocate investments based on risk profiling (group
clients into low-risk, medium-risk or high-risk categories) or
based on the investor’s lifestyle goals? (Surely the answer is to
get a balance between the two, e.g. if you are already retired and
have only R1 million, you cannot afford to take risk on board so
must adapt your lifestyle.) (11th, page 46)
Investors who have been in equity markets over the past three
years now want out. This is due to impatience and unrealistic
short-term expectations. Greed and fear are often the driving
emotions behind a belief that markets can be timed and often
result in investors getting it horribly wrong. It is more important
to be in a market than to time the market. Volatility needs to be
managed to obtain superior returns over time. Stick to your
strategy and stick to your plan. (11th, page 51)
Sir Isaac Newton said that he could predict the motion of planets
but not the madness of crowds. The market emotion cycle goes
something like this: Optimism, excitement, thrill, euphoria (peak)
anxiety, denial, fear, depression, panic, capitulation despondency
(trough) depression, hope, relief, optimism (go to start). (11th,
Page 57)
The major argument against expensing options is that they are
almost impossible to value accurately (GAAP does not require
accurate). The Black-Scholes model is dependent on inputs,
which are themselves estimates and will overstate the charge to
the income statement. (Not true – the Black-Scholes model can be
modified to apply to options with vesting rights. The only major
estimate in the model is the volatility factor. This is a small part
of the total value of an option.) A major problem is that the cost
will be expensed even if the options are deeply out of the money
and there is no chance that they will be taken up. (This would
only happen if the price of the shares has fallen after the award
and the expense is being spread over the vesting period. If they
18
Mafia Buzz 2003
were awarded deeply out of the money, they would have little
value.) (16th, Page 32)
Freddie Mac, a giant mortgage company in the US has restated its
earnings for the past three years by $1,5 billion. The difference
here is that the restatement increases the earnings! But the next
few years will see earnings lower by $1,5 billion. (30th, page 6)
Fortune
The newly formed PCAOB in the US will soon be a 300 people
powerhouse. Its first goal is to investigate and transform virtually
every aspect of auditing. Only firms registered with this body will
be eligible to perform audits of public companies. The PCAOB
will determine how auditors are paid for their services, will set
auditing standards and will evaluate audit procedures undertaken
by the firms to audit the companies. (Who wants to be an
auditor?) (9th, page 19)
Who should be penalised for corporate fraud: the company or the
executive who committed the crime? Was it fair to destroy a firm
like Arthur Andersen (thousands of innocent employees lost heir
jobs and thousands of partners who knew nothing about the crime
lost their nest eggs they had been building for years) because of
the deeds of a few executives? Why should the company pay, as
in the case of WorldCom, a $500 million fine, thereby penalising
its shareholders for the misdeeds perpetrated by its executives?
Surely the perpetrators should be the ones to pay – sit in jail for 20
years will be a better deterrent to others contemplating fraud. (9th,
page 21)
PwC has advised Amerco, the parent of U-Haul, that the special
purpose entities that were created seven years before did not meet
the criteria for off-balance sheet accounting. PwC had advised the
company on these structures and, according to the article, took the
entire blame for the mistake. PwC tried to help the company
rectify the mistake but things went terribly wrong during this
process and PwC is now facing a $2,5 billion lawsuit. (Who wants
to be married to an auditor?) (23rd, page 49)
Very skilled, very careful investors can consistently beat the
market. They don’t try to hit home runs. They hit lots of singles.
They don’t follow hunches; they follow computer models. They
don’t believe that markets are efficient but they don’t believe that
they are very inefficient either. (23rd, page 58)
The greatest insight into new finance is that investment returns are
in part a reward for taking risks. Risk means the possibility that a
share or a portfolio will go down more than the overall market. If
you earn a higher return by taking a higher risk than the market
risk, you haven’t necessarily beaten the market. Since the costs of
active trading are more than the cost of the buying and passively
holding shares, someone who simply buys the market will
invariably do better than the average active investor. (23 rd, page
59)
If you don’t read the notes in a company’s financial statements,
you are not getting the whole story. Most of the critical details are
buried in these notes. Examples:
1.
2.
3.
Growth in earnings may be attributable to acquisitions and
not organic growth. Find this clue in the notes.
Read the note on related party transactions carefully.
Study the accounting policy notes carefully, e.g. if a company
recognises revenue when goods are shipped, there could be a
“stuffing of the channel” problem (goods are ending up in
stock of the customers and not being consumed). (23rd, page
78)
Revaluations of available-for-sale financial assets (defined as nontrading 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
Techtalk
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?)
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.
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
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Mafia Buzz 2003
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.
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)
You can download the circular on headline earnings by going to
http://www.saica.co.za/Displaycontent.asp?theID=1182.
British accountants do not believe that converting to IFRS will
improve their reporting standards (they are probably right). (Page
93)
July 2003 (30 Minutes)
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)
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
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
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Mafia Buzz 2003
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)
Accountancy SA
Karin Barac looks at what companies report on their websites:
1. 86% of companies give detailed reports.
2. 77% give their share price information.
Bay Jordan says that the only way to deliver a truly consistent
customer service is to ensure that management and employees
recognise that the business depends on the customer. They must
treat customers as they would expect to be treated if they were
customers.
Alison White expresses concern that there will be too much
subjectivity in determining the recoverable value of cash
generating units when identifying whether or not goodwill has to
be impaired in terms of the proposed new statement on business
combinations.
IFAC is working on an exposure draft on continuing professional
development (CDP). (Just another way for other people to control
our lives! We need to make sure that this will not be a waste of
our time.)
My article was on how AC133 can be used to deceive the users of
financial statements.
Penelope Webb objects to giving criminals amnesty – I am on
your side madam – fine them and/or throw them in jail!
Business Day
Companies listed on the JSE will have to disclose all payments
made to directors, including directors fees, basic salaries, bonuses,
pension schemes, share options, profit-sharing arrangements and
other incentive devices as from years ending on after 1 September
2003. (3rd)
Citizen
Jackie Cameron sets out Allan Gray’s stock picking secrets:
1. Stick to the basics.
2. Understand the business you are buying.
3. Ask yourself what you would pay for the business if it were
not listed on the JSE.
4.
5.
6.
Have a margin of safety between the value and the price paid.
Assess the competitive advantage of the business.
A business is worth the cash it can pay to its owner. A
company that never pays dividends is worthless.
7. Watch for earnings manipulation.
8. Ask yourself why you want to buy the investment.
(If you have every studied Warren Buffett, you will recognise all
of the above.) (21st)
Financial Analysts Journal
Maverick risk is the risk of being wrong and alone. When agents
work on investing other people’s money, it is more acceptable to
fail conventionally than to succeed unconventionally.
A
contrarian view is not accepted until it has been shown to be
correct and has, therefore lost its relevance. It is easier to tell
people what they want to hear, even if it is wrong, than to tell
people what they do not want to hear, even if it is right.
(May/June 2003, page 6)
Investors want to be secure while they aspire to be rich, want to
save while they are tempted to spend, want to feel joy and pride
and avoid the pain of regret, i.e. human nature is human nature.
(May/June 2003, page 13)
Benchmarking allows one to measure the risk one is taking to
produce additional return. Sophisticated investors use benchmarks
to control their exposure to various markets to add “alpha”. The
craze to “beat the market” rather than to meet well thought out
investment objectives encourages one to follow the market’s
“animal spirits” rather than gauge when such risks are likely to be
rewards. (July/August 2003, page 4)
Financial Mail
Andrew NcNulty says that Primedia issued 800 000 options in
June 2000 to expire in June 2005 at a subscription price of 275
cents. In June 2000 the share price was 600 cents. Nice way of
watering down the value of existing shareholders! (4 th, Page 39)
The SEC has alleged that Coronation International Active fund of
funds systematically manipulated the month end closing prices of
certain securities and provided unfounded and unrealistic
valuation opinions to the auditors. (One must wonder how much
of this goes on in this industry. It is such a temptation, and so
easy, to manipulate valuations.) (18th, page 15)
The US based infrastructure management-company Peregrine
Systems restated its revenue of $1,34 billion by $509 million as a
result of a SEC investigation. They had allegedly included in
revenue non-binding shipments to resellers and revenues that were
reciprocal deals for customers’ purchases of software. (I have
seen the latter scam working in RSA – software providers buy
hardware for the client and charge exactly what they paid for it so
that they can include it in revenue.) (18th, page 15)
Micosoft has joined other US company icons such as General
Electric, Citigroup, Coca-Cola and Proctor & Gamble in
expensing equity based employee compensation through the
income statement. Microsoft intends phasing out stock options in
favour of issuing actual shares to managers. (8th, page 44)
Hendik du Toit of Investec Asset Management believes that as
many as 40% of local asset managers are not trading profitably.
(This makes sense – if the market stands still, >50% will not trade
profitably – remember the costs of doing a trade?) (18th, page 53)
Finance Week
Ernst & Young agreed to pay the U.S. Revenue Service $15
million to settle an investigation into the marketing of tax shelters,
which could be used to evade tax. (9th, Page 6)
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Mafia Buzz 2003
An estimated R8 billion is lying unclaimed in various investment
vehicles including life insurance policies, unit trusts, shares,
dormant accounts and pension fund benefits. (9th, page 35)
The Financial Services Board has reported that many life
companies tend to treat policy holders in a cavalier fashion and
that many of the bad practices that were found at Fedsure Life
were common in other life insurers and the industry as a whole.
Among other things it is recommended that there be a clear
distinction between policyholders and shareholders’ assets, that
the independence of actuaries be revisited and non-executive
directors of life companies receive training. (9th, page 38).
In 1990 there were 23 registered asset managers but by last year
that had increased to 301. (All chasing the same investments and
charging for doing so!) (21st, page 59)
Asset managers spend vast sums on creating brand awareness to
attract investment advisors who feel more comfortable with being
wrong with a big name player than risk being wrong with a small
manager. (30th, page 55)
The top 40 shares account for 88% of the JSE capitalisation,
which leaves only R150 billion outside the top 40 in which to
invest. (30th, page 55)
A new regulation in the Pensions Fund Act is to replace a
regulation dating back to 1956. This regulation will require
stricter corporate governance. The new version will require that
trustees have an investment strategy in place. (The fact that this
has not been in place in the past is really depressing!) A study by
Deloitte & Touche found some serious shortcomings in pension
fund administration. They found, for example, insufficient trustee
dedication, a lack of employer interest, inadequate monitoring of
governance, inappropriate investment strategies and a low level of
trustee understanding. Considering the value destruction that has
taken place in the pension management industry, one can expect
litigation on a grand scale. (30th, 58)
Fortune
The fight is on in the US about how much say shareholders should
have in the running of companies. The ballots shareholders
receive at present are just like Stalin used to distribute – for every
position there is exactly one candidate. Companies want free and
open elections about as much as Stalin did. The present rules are
based on the thinking that shareholders cannot be trusted to act
responsibly whereas managers are wise and beneficial stewards
who know what is really best for the shareholders. The thinking is
that the Sabanes-Oxley Act has not gone far enough to empower
the shareholders. (14th, page 19)
Question: Why would someone pay $7 billion for the Yellow
Pages in the US? Because when the sink leaks you do not go to
Google and search for a plumber – you pick up the yellow pages.
(SAICA must realise that their members would much prefer to
have statements like they had in the old days where they can turn a
page, find the paragraph, highlight the important words and solve
the problem. At present they have to pull the computer out of the
case, find the cords, turn it on, etc., etc.) (14th, Page 22)
The top 10 companies in the world are:
By Revenues
Wal-Mart Stores
General Motors
Exxon Mobil
Shell
BP
Ford
Daimler Chrysler
Toyota
General Electric
By Profits
Citigroup
General Electric
Exxon Mobil
Altria Group
Shell
Bank of America
Pfizer
Wal-Mart Stores
Microsoft
By Employees
Wal-Mart Stores
China Petroleum
Sinopec
US Postal Service
Agri Bank of China
Siemens
Mcdonalds
Bank of China
Carrefour
Mitsubishi
Toyota
Compass Group
The RSA companies featuring in the top 500 are (by revenue):
281: BHP Billiton (up from 302 last year)
341: Anglo American (down from 328 last year)
453: Old Mutual (down from 366 last year)
The top 10 money losers were, in $ billions:
Company
Company
AOL
99
Mizuho Group
20
Qwest communications
36
Vodafone
15
Deutsche Telekom
23
AT&T
13
Vivendi Universal
22
Lucent
12
France Telecom
20
Tyco
9
Five of the above were involved in high level accounting scandals.
(28th)
Maneo (June 2003)
Claude O’Flaherty says that practitioners should put in place
safeguards to overcome fundamental threats to independence.
These safeguards should be demonstrable and defendable.
Be aware of the following:

ED on assurance engagements

ED on the special considerations in the audit of small entities

Statement on reporting by auditors on compliance with IFRS

Guide on money laundering
The Auditing Standards Board meetings are now open to the
general public. (I really would be fascinated to see who turns up.)
Jillian Bailey sets out common problems found during practice
reviews. Get hold of Maneo, if you are an auditor, read carefully
and do not fall into these traps. All of the points are second year
auditing steps – if you hold yourself out to be an auditor, do these
things!
Techtalk
1.
The exposure draft on limited purpose financial statements
has been published for public comment. (See my website for
my thoughts on this feeble attempt.)
2.
The Implementation Guidance on AC133 is deemed to be
part of the statement.
3.
Improvements to IAS 32 and 39 are expected in March 2004.
4.
We can expect the ED on performance reporting towards the
end of 2003.
5.
The circular on headline earnings has been further
contaminated by the publication of two new issues.
6.
If you are involved in an SME or SMP and need assistance
with managing and operating your computer systems, go to
www.ifac.org/store and download controlling computers in
business: backup, archive and restore and controlling
computers in business: physical security.
August 2003 (30 Minutes)
Accountancy
The adoption of IAS 39 is facing French resistance – the French
president is encouraging standard setters to think again. (I did not
realise that he was an accounting expert!) (Page 9)
The UK companies bill could include:
1. Increased powers to regulate auditors.
2. Increased powers for auditors to obtain information.
3. Requirements to disclose non-audit services by auditors.
4. Increased role of the review panel.
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Mafia Buzz 2003
5.
Empowerment of revenue authorities to pass information to
the review panel.
6. Requirements to publish a statement on operating and
financial review. (We need this thing in RSA.) (Page 13)
Michael Howard, shadow chancellor, says that the UK
government has introduced, on average, 15 new regulations every
working day since its election in 1997. (And we thought we had it
bad!) He has promised to cut business regulation if voted in.
(Page 19)
4.
Investors should be aware that Higgs (equivalent of King in RSA)
is not a solution to badly managed companies. The best safeguard
for shareholders is the integrity of the management. Selfregulation should always be the preferred model. (Michael
Howard) (Page 19)
The proposal is that insurance companies arrive at the profit for
the year by deducting the net asset value at the beginning of the
year from the net asset value at the end of the year, fairly valued.
If you have ever seen how insurance companies calculate their
embedded values you will realise that the profits of insurance
companies in future will be dependant on what management
wishes to report. Pity the poor auditors. The author asks: “Surely
the aim of accounting principles should not be to influence or
change the business model?” (It is the cart leading the horse these
days, my friend.) (Page 84)
Toll roads in Yugoslavia are insisting on dollars from motorists.
You know that a country is falling apart when its Government will
not accept its own currency! (Page 26)
Lessons to be learned when giving advice that could go wrong:
1. Ensure that the engagement letter spells out exactly what
responsibilities are undertaken.
2. Judiciously disclaim any projections made.
3. Avoid attending meetings if you are ill -prepared.
4. Do not make statements merely to placate your client.
5. Make notes of discussions and retain these notes.
6. Consider placing an agreed cap on your liability for non-audit
work.
7. Ensure that the narrative in the fee note describes exactly
what was done. (Page 58)
Sir David Tweedie, chairman of the accounting standards board,
says that the future of international accounting standards depends
on the professionalism of accountants. He says that if you are
going to stick to principles, you need ethics. (The alternative is
principles plus rules. Dear Sir, do you really think that principles
are going to work without rules? Expecting to rely on the ethics
of accountants to ensure that the principles are applied is a big
ask.) (Page 77)
The magnificent Ron Paterson tackles the problem of what
comprises a subsidiary for consolidation purposes, with special
emphasis on special purpose entities (SPEs). Enron got away with
selling assets to SPEs at massive profits and not eliminating the
profits as the SPEs were not consolidated. He says that one
should consolidate an entity if it provides the kind of benefits to
the company that would be provided by a subsidiary. In the UK
they created a thing called a quasi-subsidiary, which had the effect
of stopping the formation of off-balance sheet entities to hide
losses, assets and/or liabilities. He believes that the IASB should
set out the principle of when control is deemed to be present and
avoid detailed guidelines. He suggests that Sir David’s “duck
test” should be applied, i.e. “if it looks like a duck, walks like a
duck and quacks like a duck, it is a duck.” (Page 78)
Companies with December year ends are supposed to convert their
balance sheets to IFRS GAAP on 31 December 2003 (yes, 2003)
because 2005 is the first full year of compliance and the opening
balance sheet of the 2003 year must be the starting point to get
comparative figures for 2004. The problem is that the new
statements on the major changes are only due in March 2004, i.e.
if they meet their deadline. As we are already IAS32 and IAS39
compliant in RSA, it is vital that we know what changes are going
to be made before we can get started on the conversion process.
In the meantime, what can you do?
1. Study IFRS 1 (AC138)
2. Watch the IASB website to monitor decisions made on sharebased payments, business combinations, etc.
3. Consider how IFRS will affect staff bonuses, tax
calculations, covenants in loan agreements, etc.
Consider how IFRS will change the way you do business
(crazy that we have to change the way we do business
because of the standard setters!). (Page 80)
There is opposition to the two statements on financial instruments
in Europe and the lobbying is in full swing. It is felt that because
of this and because of the other projects that the IASB has taken
on, the IASB is becoming stretched too thin. It looks like they
may have to abandon the insurance statement to meet their other
deadlines. (Page 82)
The IAASB has issued an exposure draft called “Review of
interim financial information performed by the auditor of the
entity” – it can be downloaded from www.ifac.org. (Page 86)
The UK’s Urgent Issues Task force is working on accounting for
emission rights. Say the Government gives the entity the right to
emit 100 tonnes of CFCs. If it emits less than 100, it may sell the
balance to other polluters. If it emits more than 100 it must either
buy rights from another entity or pay a fine. Assume the right to 1
tonne is worth R10 and the company uses 60 tonnes by its halfyear:
Emission right asset
Dr.
1 000
Deferred income
Cr.
1 000
At grant date. (Is this not lovely – create an asset out of fresh air?)
Expenses
Liability
Used.
Dr.
Cr.
600
600
Deferred income
Dr.
500
Expense
Cr.
500
Resulting in a net charge of 100 to income.
(Note: I have not yet studied the IFRS E.D so cannot compare the
UK proposals with the IASB ones.) (Page 91)
Good news for auditors! Although Delotte & Touche was found
to be negligent in relation to its audit of Barings, the judge held
that management carried a high level of fault for loses suffered
and damages should be apportioned. (Page 105)
The mission of the president of the ICAEW is to bring together
business, regulatory and investing communities to examine how
they can devise a reporting framework that fulfils market needs for
the provision of truly useful information for decision making. (I
thought that this was what the IASB was trying to do?)
Business is realising that sick leave is a high cost. Businesses
must create a positive climate when people want to come to work.
Businesses cannot afford to pay for people who do not turn up to
work. Few businesses have accurate attendance records and
cannot, therefore, spot absentee trends. The following five
reasons are given for staying at home: Cold/flu (93%), food
poising/upset stomach (77%), headache/migraine (64%),
stress/emotional problems (54%) and back problems (47%). (Page
114)
Want to increase your fertility? Stopping smoking improves it by
20% to 50%, reducing alcohol intake to less than one drink a day
improves it by 20% to 50%, and reducing caffeine intake to one
cup of coffee per day improves it by 25%. If all else fails, trade
your man in for a younger model. (Page 116)
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Mafia Buzz 2003
Accountancy SA
Michael Dorfan addresses the problem of accounting for defined
benefit plans. His message is to get companies to disclose the true
legal liability for defined benefit plans. (Page 4)
Wilna Steyn and Willie Hamman (or is it Pieter von Wielligh?)
look at the mistakes companies make when preparing cash flow
statements. (From my experience, few preparers, auditors and
users understand AC118! Time to throw this cash flow statement
out and get something that is more meaningful like the old source
and application of funds statement?) Points made in the article are:
1. Only half of the companies have an accounting policy note
on what is meant by “cash and cash equivalents”.
2. One company says that bank overdrafts are part of cash and
cash equivalents and yet includes increases in bank overdrafts
as a financing activity.
3. Some companies included the current portion of long term
borrowings in cash and cash equivalents.
4. Some companies have given bonds to the banks in respect of
their bank overdrafts and yet show them as part of cash and
cash equivalents. (Page 10)
SAICA points out that until the Financial Reporting Bill is
approved by Parliament (who knows when) SMEs will have to
comply with the existing accounting rules, i.e. do not get too
excited about differential reporting just yet. (Page 15)
My article was on agricultural futures – looking at whether or not
they could be weapons of mass destruction. (Page 18)
45,3% in total passed part 1 of the 2003 Q.E. with a 20,5% pass
rate for black candidates. (The apartheid school system is still
being felt? Or are they still penalising candidates for not having
perfect English – the typical black candidate is writing in his or
her second or third language so is at an automatic disadvantage.)
(Page 37)
If you failed part 1 of the examination, get hold of this journal and
study the examiners’ comments carefully on pages 46 and 47. The
sick thing is that every year the same comments are made and
every year candidates fall into the same traps. Why can’t people
realise that it is so much cheaper to learn from the mistakes of
others? I loved the quote at the end of the article: “There are no
shortcuts to anyplace worth going.” Investing in the future seems
to be foreign to the “now” generation.
Business Day
The JSE listing rules that have just been published will be a
windfall for accountants and merchant bankers. (When will the
shareholders start objecting to this redistribution of income away
from the true owners of the companies?) (27th)
Business Times
Nigel Scott says that there are two ridiculous myths in the advice
game:
1.
You can never have too much insurance – you only need
enough to settle your liabilities on death. (I have no liabilities
so I have no life insurance – and do not try to sell me any!)
2.
The ideal equity exposure in an investment portfolio is 100
minus your age – you must take all factors into account when
doing the allocation step, not just age. (17th)\
Citizen
Michael Lauer, the fund manager of Lancer Management Group
(LMG) was charged by SEC for grossly overstating the assets in
the fund, thereby attracting investors (shades of our own Jack
Milne). He pumped up values to the amount of over $1 billion.
One of the RSA funds has taken a major knock on its investment
LMG. (I have been waiting for something like this to happen.
Are Jackie and Micky only the tip of the iceberg?) (4th by Shirley
Kemp)
Finance Week
Deon Basson states that the large number of exceptional items
making up the difference between attributable-profit and headline
earnings contributes to a general scepticism about companies’
headline earnings. He states that it is a useless measure on which
to calculate the price earnings ratio. (Deon, headline earnings was
never meant to be used to assess the real performance of a share.
It is merely a measure to compare the trading performances
between companies. If you want to value a share using earnings
as a basis, you should strive to discover the company’s
maintainable earnings, which measure cannot be arrived at by
applying a set of rules.) (4th, Page 12)
The following note appears in the financial statements of Aspen:
“For hedge accounting purposes relating to transactions with
suppliers that are denominated in foreign currency, the settlement
of the creditor is now designated as the hedged item as opposed to
the import transaction.” (Nice – pretend that a cash flow hedge is
really a fair value hedge! I wonder how the auditors felt about
this?) (Page 13)
Financial Mail
Andrew McNulty says that AC133 is introducing greater
complexity and less predictability for banking groups. For
example, First Rand included a R233 million gain from AC133 in
its core operational earnings. He says that because short-term
earnings are going to be more volatile, more attention will have to
be given to net asset value and return on equity. (ROE is earnings
divided by equity – how will this help?) (1st, page 65)
A research team reviewed the records of workers on a tea
plantation in Kenya over five years and found that during the last
three years of life, tea pluckers who died of Aids were absent from
work almost twice as often as other tea pluckers. (8th, 43)
Andrew McNulty comments on AC133:
1. It has had a marked influence on balance sheets and income
statements.
2. The effect on earnings, growth rates and profitability ratios
has been positive (I do not know where he gets this from).
3. The banks have not been consistent with the application of
the statement.
4. The current thinking could change.
One inconsistency between banks is the treatment of impairment.
Previously, banks used to make two provisions, a specific
provision and a general provision. Only a specific provision is
now permitted based on a projection of future cash flows expected
from debtors. Standard Bank released R499m from general
provisions to the opening balance of retained income. Nedcor
released R1,72bn of the general provision and created an
additional R1,13bn additional specific provision leaving R585
million which was released. (Apparently, the profession is
insisting now that these releases go to income and not to the
opening balance of retained income. GAAP gone totally mad!)
(22nd, page 48)
Fortune
Quotes from some of the top “Greatest CEOs in the US”:
1. We have a responsibility to our employees to recognise their
dignity as human beings and believe that those who help
create wealth have a moral right to share in that wealth.
(David Packard)
2. To opt for assured survival at the cost of the company’s soul
would be worse than not surviving. (Katharine Graham)
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Mafia Buzz 2003
3.
4.
5.
6.
7.
8.
9.
You must battle attempts to kill off your ideas. Without
creative tension, i.e. freedom vs. discipline, innovation vs.
control, all you have is chaos, or worse. (William McKnight)
We hold these truths to be self-evident, among them a higher
duty to all who use our products. (James Burke)
You must be willing to act boldly. (Darwin Smith)
Our products are for people, not for profits. (George Merck)
Set goals just beyond your grasp. Have a hunger for
learning. (Sam Walton)
Have a grand vision. (Bill Allen)
Create ideologies and mechanisms that will stand the test of
time. (Charles Coffin) (18th, page 65)
Techtalk
The amendments to the JSE listing requirements are now complete
– can get them from LexisNexis (the old Butterworths). Some of
the major changes are:
1. Directors take personal responsibility for compliance.
2. Listed companies must have a permanent sponsor (more
money out of the shareholders’ pockets into those of the
professionals!)
3. On the date of issue of the AFS companies have to publish
abridged AFS on SENS.
4. Auditors must review voluntary preliminary AFS prior to
publication on SENS.
5. Directors must obtain clearance before they can trade in their
company’s shares.
6. The GAAP Monitoring Panel will censure and penalise for
not complying with Statements of GAAP.
7. The threshold for related party transactions has been reduced
from 10% to 0,25%.
ED162 on emission rights has been exposed. If you want to see
GAAP gone mad, read this one!
The IASB is fiddling with the statement on provisions – I think
that users and preparers are going to get angry about this constant
changing of minds!
The Law Society of SA is not happy with the audit reports being
given in respect of trust accounts. They are of the opinion that the
cost of the audit report exceeds the benefit derived from them.
(What about private company audits?)
IFAC’s Board agreed that it would operate with integrity,
transparency, efficiency and simplicity. (What? Have they not
been doing so in the past?)
The former Governor of the Bank of Canada is charged with
finding out why financial reporting has lost credibility and will try
to find ways to restore it. “The report will be released around
midyear.” (This was the August Journal. Maybe in Canada they
have a different year to us.)
The IAASB has issued an exposure draft on quality control for
audit, assurance and related services practices.
September 2003 (30 Minutes)
Accountancy
The IASB has issued:
1.
ED 4 on the disposal of non-current assets and presentation
of discontinued operations. They have reverted to the
original idea of a discontinued operation instead of a
discontinuing operation (round and round we go – will it ever
stop?)
2.
ED 5 on insurance contracts. (You don’t want to know what
they are proposing!)
3.
An ED on fair value hedge accounting for a portfolio hedge
of interest rate risk. (Page 12)
In the UK they have issued a code to enable employees to take
action against employers for not protecting them adequately
against stress. (What about the stress of the employer caused by
the employees?) (Page 13)
The IAASB has issued an exposure draft on the auditor’s
responsibility to consider fraud in an audit of financial statements,
which suggests that auditors should act with increased
professional scepticism. (When are they going to admit that it is
the responsibility of the auditors to look positively for fraud?)
(Page 13)
It is felt that if liability caps are not permitted on audit
responsibilities, we could end up with the big three (two, one, …?)
(Page 22)
A good leader understands all the people in the team and treats
them as they need to be treated and makes them feel good about
themselves and confident. (Page 24)
Auditors (and directors, please) must learn that the full truth must
be told, irrespective of the cost. They must not abuse the trust of
the readers of financial statements. (Page 26)
In the UK they will be installing a principles-based system of
compulsory continued professional development. It will not be
necessary to notch up x number of hours or score x number of
points. The system will require members to plan their own CDP
system to meet their own goals. They will be required to provide
a declaration that they have undertaken this process and provide
evidence, if required to do so. (The UK professionals really are
logical. I hope for our members that something as logical as this
will be installed in RSA. Let’s avoid the big stick. Let’s avoid
wasting time on things that do not add value. I think it is essential
that professionals have a CDP project, but it must be their project,
i.e. it should not be forced on them by some bureaucrat.) (Page 49)
When Rafat Bhatia raised concerns about the legality of a stock
exchange transaction, the chairman of the company threw his
digital diary at him and threatened to destroy him. He was
awarded compensation of ₤805 000. PwC says that companies
that do not have whistle-blowing policies are missing a trick. (The
problem is that this is the last thing crooked management want
when they are going to be blown up themselves!) The audit
committee should take responsibility for a company’s whistleblowing policy. However, despite any policy in place, it will still
take a brave employee to put house, livelihood, family and
reputation on the line by blowing the whistle. (If you were in a
situation where you had your whole career ahead of you, would
you blow the whistle? I have, on occasions, suggested that
employees resign as an alternative. This is what the auditors are
paid to do!) (Page 52)
Moores Stephens faces a damages bill of more than ₤190 000 after
a high court ruling that it gave negligent tax advice. (Who wants
to be a tax advisor?) (Page 73)
An auditor valued a start-up business that had developed a
photographic process, which had not started generating income,
for an outgoing shareholder at the accumulated cost of the
development. It was sold subsequently for eight times the cost.
The ex-shareholder sued the auditor for negligence. However, it
transpired that the purchaser of the process had discovered that the
process was fatally flawed so had scrapped it. So the shareholder
did not get damages. (Thank goodness the auditors did not do the
due diligence for the purchaser of the process! Doing valuations
is a dangerous game.) (Page 75)
The traditional annual budget is a pointless and time-consuming
process that piles pressure on people who already have a full time
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Mafia Buzz 2003
job to do. Many organisations have moved to rolling forecasting.
(Page 84)
44% of working adults in the UK do not pay into a pension
scheme and 66% have not planned for retirement. There is little
consideration for financial survival past working age. Over 90%
of those surveyed felt that there should be some form of financial
education in the national curriculum. (Really think this will help?
I am sure that the situation in RSA is a lot worse than the UK)
(Page 89)
The EU has endorsed all IASs except the controversial IAS 32 and
IAS 39. (Page 95)
A revised draft on ethics proposes that the code be elevated to a
standard to be adopted by national bodies around the world. (Page
95)
IFRS will impact business processes, management reporting,
systems and the way shareholders and market analysts view the
results of companies. Few companies are considering how to
communicate the impact of IFRS on their results. A major
awareness education and training programme will be necessary
before IFRS is implemented. (This is not going to be a major deal
in RSA as we are already compliant with half of the IFRS
statements to be published. The major issue is how the big four
are going to interpret the new statements and what kind of
pressures they are going to exert on their clients. I predict that
some clients are going to revolt when they see the costs and the
impacts on their results of IFRS.) (Page 96)
Questions companies should be considering in regard to the
implementation of IFRS are:
1. Has a needs-analysis for each of the stakeholder groups been
performed?
2. Is a training and development plan for management and staff
in place?
3. Are the analysts and shareholders aware of the impact of
IFRS on the results?
4. Does the company understand how the analysts’ and
shareholders’ view about the company will be altered?
5. Has the company installed a system to ensure that the staff
will keep abreast with developments?
(That is what I am here for folks!) (Page 97)
The new ED on insurance contracts will put a stop to the
following practices:
1. Measuring insurance liabilities on an undiscounted and basis.
2. Measuring insurance liabilities with excessive prudence.
3. Reflecting future investment margins in the measurement of
insurance liabilities.
The ED contains proposals that would require the unbundling of
deposit components of insurance contracts and limit reporting
anomalies when buying reinsurance. (Page 98)
Ron Paterson deals with some of the terms used by standard
setters:

“Highly probable” means “significantly more likely than
probable”. “Probable” means “more likely than not”. So
“highly probable” is “significantly more likely than more
likely than not”. Unfortunately, they do not define what
“more likely” means!

“Possible”, in the definition of a contingent liability, means
“less than probable” but in the case of a contingent asset
means “less than virtually certain”.

He asks what “remote” means: is it the obverse of “virtually
certain”? (Page 101)
SEC has issued a staff study recommending that accountingstandards be developed using a principles based approach. It
proposes that they:
1.
Be based on an improved and consistently applied conceptual
framework.
2. Clearly state the objective of the standard.
3. Provide sufficient detail and structure so that the standard can
be applied on a consistent basis.
4. Minimise the use of exceptions from the standard.
5. Avoid the use of percentage tests that encourage preparers to
evade the intent of the standard.
(I read the executive summary of this document. They are
recommending a new system based on defining the objective of
the standard. The new system will embrace principles and rules.
There is no way that the US is going to admit that the ISAB has
got the “right” approach!) (Page 104)
Accountancy SA
Bernard Agulhas and Louis de Koker discuss the impact of the
money laundering control laws on accountants and auditors, e.g.
identify clients, verify certain particulars, keep records, train
employees, etc. There is now a duty to report suspicious
transactions. If this could affect you, study the full article. (Page 2)
Karin Barac looks at the implications to the auditor of Internet
reporting of financial information by companies. The US
standards on auditing state that electronic sites are a means of
distributing information and not documentation, which has been
interpreted to mean that auditors do not have to verify the
accuracy of this communication. However, the Auditing Practices
Board in their Bulletin published in 2001 stated that the auditor
does have a responsibility in this regard. The auditor should,
among other things, ensure that the electronic version is identical
to the printed version of the financial statements. (This is a tough
ask! It is easy to change the information. Must they check every
week, month, two months, quarter, etc.?) (Page 10)
The US lawmakers do not trust management, accountants, auditors
and lawyers to do the right thing so now require massive
duplication of resources and effort to enforce compliance. The
costs of compliance will increase astronomically – could average
$3 million p.a. for US companies, which could push marginal
companies over the edge. (Question: “Who ends up paying for
this: the consumers or the shareholders? The other question to ask
is who is going to be making money out of all of this?) (Page 13)
Wilna Steyn and Willie Hamman (and now Heidi Smith) continue
their discussion on cash flows. The points made are:
1. Companies are netting cash flows instead of showing gross
movements.
2. Companies are showing in their cash flows items that are not
cash flows. (How can they be sure? If a cheque was
received on the issue of shares and a cheque paid to settle the
debt, then there was a cash flow!)
3. Companies are not providing information by way of note on
their non-cash flow movements.
4. Profits and losses on the sale of investments are not reversed.
5. Minority share of profit was shown as an increase in the
financing activities of a company! (How did they balance?)
6. Some companies treat loans to employee trusts as a financing
activity. (If the shares were issued to the trust and the loan
resulted from the issue, there would be no cash flow.)
7. One company treated the payment for environmental
expenditure that had previously been provided for as a
financing activity. (The statement on provisions requires the
interest on the provision be treated as interest paid. So I can
empathise with the company in what they did!)
(My question: If you buy an asset on a finance lease with no cash
flowing, neither the asset nor the liability appears in the cash flow
statement. How do you then handle the rental payments? An
operating activity (it is rent) or a financing activity (the capital
repayment is paying off the liability) or an investment activity
(you are buying an asset in instalments)? (Page 14)
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Mafia Buzz 2003
Graeme Tosen looks at the meaning of VAR (value at risk). From
what I can gather from the article (statistics, among other things,
has never been my strength) VAR is “the amount of loss relative
to a mean return”. The example given in the article states that if
the expected return (mean) is R3 million and the standard
deviation of this return is R7 million, then:
VAR at a 90% confidence level is 3 – (1,28 x 7) = R6,0 million
VAR at a 95% confidence level is 3 – (1,65 x 7) = R8,6 million
VAR at a 99% confidence level is 3 – (2,33 x 7) = R13,3 million
Or, to put it another way, there is a 10% chance that you can make
a loss of R6,0 million, a 5% chance that you can make a loss of
R8,6 million and a 1% chance that you can make a loss of R13,3
million. (I would have thought that one could halve these
percentages as we are only dealing with one side of the population
mean. Can anyone help?)
Let’s try this idea on Pick ‘n Pay’s shares:
I would expect to earn a return (has been achieved) of 1% p.m.
The standard deviation of the monthly returns has been 14% p.m.
This means that I can be 90% confident that I will not incur a loss
of more than 16,9% in any one month from my investment in Pick
‘n Pay. Over the past 74 months the actual number of times
16,9% was exceeded was 3 times i.e. 4% of the times. (See why I
think the 10% should be halved? Or was this a fluke?)
One of the best articles I have ever read in a finance journal is:
“AC133 is a nightmare, says business”. Some of the points made:
1.
The French are the most vociferous critics of IAS39 – the EU
has sent it back to the drawing board. (South Africans, with
respect, are like a bunch of sheep – we accept anything that is
thrown at us. Time to wake up?)
2.
RSA has been made the guinea pig for this new accounting
standard – can we afford to be the leaders? (Sure – lots of
money to be made out of this experiment – remember those
making the money out of AC133 are the people who pushed
for it to be implemented. Commerce and industry did not
fight it so they are now paying the price.)
3.
AC133 provides insight into the risk behaviour of companies.
(I do not agree. Until companies are stopped from hiding
gains and losses on forex in assets imported and in export
sales, users will not be able to get insight into risk
management policies and their effectiveness.)
4.
The cost of implementing AC133 has been about R100
million to the banks. Shareholders have had to foot the bill.
5.
AC133 has pushed the disclosure requirements for insurance
companies from 2 500 to 6 000 items!
6.
Why did we have to take the initiative in RSA when further
developments are on the cards? This is not in the best
interests of SA. (One bank I lectured to recently said that
they would consider suing the profession for the additional
costs incurred if major changes are made to the statement
requiring further system changes.)
7.
SAICA points out that the APB is the standard setting body
and not SAICA. (Who pulls the APB strings?)
8.
SAICA points out that IAS39 is not new to the world – the
US has been using a similar standard for years.
9.
Mike Gresty says that he is still unable to make appropriate
adjustments to reported results to arrive at comparisons
between the various banks.
My article was on the journal entries and tax implications of
agricultural futures.
Business Day
IBM was found guilty in the US for tampering with pension fund
earnings to boost its own profits. (You can’t even trust the big
blue!) (15th)
Sanchia Temkin was clearly brainwashed into publishing an
article stating: “In a revolutionary accounting development, SA is
to adopt a differential reporting system for SMEs.” She says in
the article that SMEs will be able to “tailor their financial
reporting to the needs of the users of their financial statements.”
(Dream on lady! Maybe when our small practitioners have had
their say, and SAICA has accepted their points of view, this may
be a reality.)
Finance Week
Deon Basson, (how does he find all these scandals?) tells the story
about Corpcap’s accounting for its investment in Cytech. In short,
the investment, which was considered to be a long-term strategic
investment at the time, was revalued two years in a row to income
(and included in headline earnings). When things started going
wrong the investment was written down “below the line”
(presumably outside headline earnings). What I find intriguing
about this whole saga is the note by the audit committee in the
financial statements. It read: “In due course the audit committee
will consider and make recommendations to the board regarding
any write down, which may be required for this investment over
and above the monthly amortisation of goodwill in accordance
with the company’s accounting policies.” If they were amortising
goodwill, this investment could only have been an associate
(47,5% holding). How then could the revaluation have gone to
headline earnings? A second problem here is that the standard
setters have got in wrong by stating that a long-term strategic
investment revaluation goes to headline earnings! But then they
will never own up to this mistake.) (10th, page 12)
The R300 billion strong Public Investment Commission, which
manages the Government employees’ pension funds, wants to
harness these funds for empowerment. The PIC feels that it
should focus on issues other than returns. (And create poverty for
the pensioners of the Government in future years!) (10 th, page 15)
One good thing about this statement is that it is forcing all of us to
try to understand the murky world of hedging and derivatives.
(17th, page 8)
Mr Andre Viljoen explains SAA’s AC133 accounting. SAA may
only borrow 15% onshore in rand. 85% has to be borrowed
offshore in dollars. At any point in time SAA has significant
borrowings in the form of loans and leases and its foreign inflows
are insufficient to cover all foreign outflows. It protects itself
from adverse movements in the rand by covering forward. If the
rand depreciates, it benefits from the hedging operations. If the
rand strengthens, losses are incurred and the assets are worth a lot
less so have to be written down. What happened was that the rand
strengthened, assets had to be written down, and a loss was made
on the derivatives. This made SAA insolvent at the year-end.
However, the very next day SAA started recognising embedded
derivatives, which had a value of R4,9 billion. This restored
solvency to the company. (What makes you think that accounting
has sunk to the level of mumbo jumbo black magic?)
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. (5th, page 15 of innovations)
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Mafia Buzz 2003
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.) (19th, 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.) (22nd, 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 nonpayment 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 noncore, 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.
What you Always Wanted to Know But . . .
A claw-back offer is where a company issues new shares which
are taken up by a single shareholder who then grants the other
shareholders the right to buy them back (the claw back) from him
in the same proportion to their existing shareholding. The reason
for going this route is to save the underwriting fee, which is
usually about 2% of the total amount. (Could it also be that the
single shareholder is looking to pick up some more shares if all of
the shares are not clawed back?)
Intaxication is the euphoria at getting a tax refund, which lasts
until you realise that it was your money to start with.
Published Financial Statements
Quyn Holdings eliminated the loss on the sale of investments from
the calculation of headline earnings. Well done! You’ve got the
logic but lack the GAAP.
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Mafia Buzz 2003
InfoWave published its financial statements in a language I cannot
start to understand. I presume that “Imali eqoqwayo” is
“revenue”. I really think that this is taking “politically correct” to
extremes. Maybe they just do not want us whities to invest in the
company?
the radio a few years ago that there are three types of people:
those who visit a doctor and get better in three days, those who
visit a homeopath and get better in three days and those who carry
on working and get better in three days. The latter works for me.)
“Barloworld said forward exchange contracts taken out by its
capital equipment business in SA have resulted in a loss of R292
million due to the rand strengthening against the dollar. The
contracts were taken in order to cover the machine parts
purchases.” (Press report) (I really do not understand this. Surely
this is a cash flow hedge that does not go to income. It really will
be interesting to see if large profits will be reported when the rand
starts strengthening. Watch this space.)
October 2003 (30 Minutes)
Titbits
Here are some beautiful quotes from Berkshire Hathaway’s letter
to shareholders by the famous Warren Buffett:
1. It is hard to teach a new dog old tricks.
2. My retirement is scheduled for five years after my death.
3. Derivatives and the trading activities that go with them are
time bombs, i.e. weapons of mass destruction.
4. Parties to derivatives have enormous incentives to cheat in
accounting for them due to the subjectivity that goes into
their valuation.
5. Despite three years of falling prices we still find very few
stocks that interest us. This is testimony to the insanity of
valuations reached during the great bubble.
6. Occasionally successful investing requires inactivity.
7. Accountability and stewardship become qualities deemed of
little importance by those caught up in the great bubble.
8. Directors must react as did the chorus-girl bride of an 85-year
old multimillionaire when he asked whether she would love
him if he lost all his money. “Of course” she replied, “I
would miss you but I would still love you.”
9. It is desirable to have independent directors but they must be
business-savvy, interested and shareholder oriented.
10. The key job of an audit committee is to get the auditors to
divulge what they know.
11. Watch out for companies that display weak accounting
standards.
12. If you cannot understand a footnote, management does not
want you to understand it.
13. Managers that always promise to make the numbers will at
some point be tempted to make up the numbers.
Fun Corner
The best time to get an epidural is when you find out that you are
pregnant. (Finance Week, 6 August, page 74)
After a weekend of partying with his mates, a married man returns
home to a barrage of abuse from his wife. Eventually she makes
him an offer: “How would you like it if you didn’t see me for a
couple of days?” He cannot believe his luck so says: “That will
suit me just fine.” For the next four days he never saw her.
Eventually the swelling did go down and he could see her again
out of the corner of his left eye. (Finance Week 20 August, page
82)
The six secrets of a perfect relationship for a woman are:
1. He must have a job.
2. He must help her around the house.
3. He must make her laugh.
4. He must be honest.
5. He must be good in bed.
6. The above five men must not find out about each other.
(Financial Mail, 1 August, page 106)
The art of medicine consists of amusing the patient while nature
cures the disease. Voltaire. (A qualified doctor/homeopath said on
Accountancy
Business in the UK is hostile to quarterly reporting. The concern
is that this requirement will add to the burden of operating as a
listed company. It will have the effect of encouraging short term
thinking in companies and among users. Companies (and their
auditors) are relieved that the EC has proposed that no audit
review will be required on quarterly reports. (Want to guess what
the outcome will be in RSA?) (Page 36)
Chris Frost says that sustainable corporate growth depends on
strategic management of volatility – cutting costs with an eye to
the future, instead of embarking on knee-jerk slash and burn cost
reduction. However, some companies are still confusing shortterm shareholder appeasement with effective strategic cost
management, and in the process, risk being under-resourced in key
areas. During downturns, companies should be prepared to invest
in activities that add long term value – and on cutting costs in
areas that do not damage the business. Achieving the right
balance is a real challenge. (Surely, one should always (not just in
downturns) be looking to keep costs under control?) (Page 47)
The EC has decided to adopt 38 of the core 40 IASB standards.
They have rejected IAS 32 and IAS 39. The French president,
Jacques Chirac, stated that the IASB is writing standards that
threaten not only the stability of the European companies but also
the stability of the European economy! (Well said sir! We need
someone in RSA to stand up and be counted like this. Mr T.M?)
(Page 78)
The IAASB has issued an ED on the auditor’s responsibility to
consider fraud in an audit of financial statements. It says that the
primary responsibility for prevention and detection of fraud is
with management. (So what’s new? Auditors need to take on this
responsibility to reclaim the high ground.) (Page 82)
Two articles deal with the problem of macro hedging of interest
rate risk. As this is now history (the standards have now been
published) there is no point debating the problem. (Pages 83 and
84)
Ron Paterson is flogging his favourite dead horse again – arguing
that the matching concept should override the balance sheet
principle. As much as I agree with him, the battle has been lost
and fair presentation of profits is not achievable under IFRS.
(Page 88)
Emile Woolf says that the audit function as an affirmation of
reporting integrity has become an object of derision (Enron,
WorldCom, Xerox, etc.). He says that the audit function has
evolved from “if it moves, tick it” through substantive, systems
based audits, then risk-based audits, culminating in the latter-day
curiosity referred to as “business risks strategic auditing”, which,
when the esoteric flannel is peeled away, is basically a licence to
do no auditing at all. He believes that more effective corporate
governance, more power to audit committees and non-executive
directors, rotating audits/audit partners and banning non-audit
services is moonshine. He says that we should have another look
at how audits are done! (Page 91)
Accountancy SA
Graeme Tosen writes an excellent article explaining how duration
and convexity are calculated, what they mean and how they are
used. How I wish that such a clear article on the topic was
available when I was studying for my CFA examinations! If you
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Mafia Buzz 2003
are a CFA student, go for this one. For the SME practitioner, it is
not for you! (Page 7)
The two ladies from the University of Stellenbosch have written
another brilliant article on the cash flow statement. It is quite
obvious to me that this statement is not being given the attention it
deserves in practice. Here are the cash flow statement issues
discussed:
1. How should a share buy-back be treated? I agree with the
authors – it should be a financing activity. Examples are
given where local companies treat it as an investment
activity.
2. How should a reissue of shares bought back be treated? I
agree with the authors – it should be treated as a financing
activity. Again, examples are given where this is treated as
an investment activity.
3. How should contributions to a defined benefit plan be
treated? This is clearly an operating cash flow. I cannot
understand why the authors want Afrox to deal with these
contributions separately in their cash flow statement. They
say that Rainbow Chicken showed this as a financing
activity!
Hopefully this series of articles will make preparers and auditors
more aware of the pitfalls of the cash flow statement. I was
looking at a company the other day and found the cash flow
statement to be a disaster. I checked on the auditing firm and
found it to be a firm that I lecture to on a regular basis. The
partners seem to be quite blasé about the fact that the cash flow
statement is not in accordance with AC118. They are probably
not aware of the viciousness of the JSE review panel! (Page 18)
Taxable income derived from a permanent establishment outside
RSA must be calculated using the average exchange rate for that
year of assessment. The taxpayer has a choice as to how this rate
is calculated. Whatever choice is made, it must be applied
consistently. GAAP requires a suitable average rate to be used in
accounting for foreign income so there should not be a deferred
tax problem here provided GAAP and the tax choice are the same.
There would need to be clarification on how to calculate
depreciation/wear and tear in this situation. I have never quite
grasped the principle of depreciation in a foreign entity – the
balance sheet is translated at closing rate but the depreciation at?
We probably need to clarify this situation. (Page 17)
My article was on embedded derivatives in import supply
contracts. (Page 32)
Business Day
In a study done some years ago, the Economist found that refuse
collectors were consistently the best forecasters of the economy
due to their knowledge of what people throw away. (2nd)
The new Postal Services Amendment Act makes it illegal for a
private company to deliver a bunch of flowers, a bottle of pills or a
pizza. (You had better clear your car of anything weighing less
than 1 kg in case you get stopped and searched!) (2nd)
The Pension and Provident Action group, under the guidance of
SAICA has proposed a new accounting standard for retirement
funds. (About time too.) (3rd)
The third largest retailer behind Wal-Mart Stores of the US and
Carrefour of France has turned over a new leaf after losing 63% of
its value in one day due to an accounting scandal. The managers
are now going to focus their attention on the business! (3 rd)
WJ Morgan, the derivative dealer who was responsible for losing
R1,3 billion of a pension fund’s assets, was fined R2 million. It
was concluded that they had “cheated, defrauded and deceived a
client and committed acts, which were considered to be dishonest,
fraudulent or dishonourable.” (Who gets the benefit of the fine?
The JSE? Surely the pensioners should benefit?) (3 rd)
Following on from the previous paragraph, the FSB is probing
whether the pension fund may have acted criminally by taking
kickbacks from WJM. The pension fund had contravened the
pension Funds Act by investing more than 2,5% of its assets in
derivatives. (8th)
Albert Grey, former president of the Prudential Insurance
Company spent his life searching for one quality that all
successful people share. His conclusion was that successful
people do things that failures don’t like to do. (Like being at
the office at 4 a.m. on Christmas Day writing Mafia Buzz.) (20th)
Jigsaw Holdings had two interesting adjustments to arrive at
headline earnings:


Intangible asset (not goodwill) amortisation
Impairment of loan to share incentive scheme (I agree with
this but SAICA says they are wrong)
The JSE is trying to force companies to consolidate their share
incentive schemes. I have no idea where this comes from. (20th)
Proposals have been made to make company directors, bankers,
advisers and lawyers personally liable if they give auditors false
information relating to a company’s financial statements. (20th)
Citizen
Jackie Cameron gives seven ways to boost your savings: (13th)
1. Set aside money for your retirement.
2. Save first and then spend.
3. Bale out of your poor investments.
4. Build a mix of investments (diversify).
5. Use Rand cost averaging to build your portfolio.
6. Do not gamble with your savings.
7. Make use of legal tax breaks.
Financial Mail
David Alcock of the Broll Property Group sounds a warning that
valuers should have a duty of care to investors but questions
whether this exists and whether they have access to the requisite
market intelligence to do their jobs properly. (As soon as financial
statements are based on valuations, their reliability plummets.
One must ask the question whether their relevance improves. One
asset manager recently commented to me that companies should
give all the information and let the asset managers do their job in
arriving at value. There was general consensus on this point
within the group.) (10th, page 10)
Following on from the previous story, the net asset value of
Arnold Property Fund fell by 75% due to a new method of valuing
its properties (and liabilities). They changed over from a “simple
capitalisation model” to the “discounted cash flow method” of
valuing properties. (I thought you had to use market value!) Fair
value accounting is undermining the reliability of financial
statements. The standard setters have no idea of the monster they
have created by insisting on fair value accounting. (10th, page 84)
Government and regulatory authorities need to take a step back
and come up with reporting requirements that do not impose
unnecessary burdens on companies. It would be self-defeating if
economic transformation ran aground because costs became
prohibitive.
Complicated regulations and compliance
requirements kill businesses and stifle entrepreneurship. (Does
anyone take note of such comments?) (24th, page 14)
A summary of the recommendations of the panel appointed to
examine legislation affecting accountants and auditors is:
Yes to:


A new regulatory body to subsume the PAAB
Mandatory deregistration of auditors for fraud or serious
dishonesty
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Mafia Buzz 2003

Statutory offence for executive management or their advisers
to lie to the auditor

Mandatory audit committee of non-executive directors at all
listed and large companies

Audit committee to have power to appoint auditors and deal
with issues of auditor independence

Auditor obliged to meet the full board of listed or large
companies at least once a year

Establishment of a fund to compensate parties who lose from
an audit failure (It will have to be a BIG fund!)
No to:
is allowed to focus on satisfying its customer needs without all the
surrounding garbage that goes with being listed or being a
company – my comment!) (22nd, page 17)

Sir Richard Branson’s five rules for success are: (6th, page 30)
1. Follow your passions.
2. Keep it simple – it keeps you focused.
3. Get the best people to help you.
4. Re-create yourself.
5. Play (and does he know how to do this!).
“The key thing I’ve learned is to listen. You don’t have to have
the last word. You don’t have to get credit for anything. I’ve
always led people around a table when discussing issues. But now
I hold back what I think. I say to myself ‘not now, not now!
Wait, wait!’ This new approach has changed my life. I avoid
publicity like the plague. I am trying to live in the here and now
instead of wondering what the next job will be. That is a very
freeing thing.” (Debby Hopkins, who was forced out of Lucent as
CFO) (13th, page 62)
Statutory limitation on non-audit services an audit firm may
perform for a client

Compulsory rotation of audit firms or audit partners at a
client

Auditors having a financial interest in a client (Don’t agree)

Legislation on internal audit
(24th, page 46)
The labour court in Durban has ruled that if an employee is
dismissed and has not been allowed to take his/her full leave,
he/she must be paid out in full for the accrued leave, even if it is in
excess of the statutory minimum. (31st, page 46)
The Small Business Project has called on government to ease the
tax burden for small businesses. (Last month I took my one
cheque covering PAYE, Skills levy, UIF and VAT to be deposited
and was informed that FNB will no longer accept one cheque for
four invoices to be paid to SARS. Just work out how much
additional bank charges the banks are going to earn because of this
action, and what the SMEs are going to lose. You can’t win!)
(31st, page 46)
Finance Week
Britain’s Financial Services Authority fined Lloyds R22 million
and ordered it to pay R1 billion in compensation for selling a
failed financial product. (1st, page 6)
“One of my most important tasks is to make each of our 16 700
employees realise that the more innovative and entrepreneurial
they are, the more successful we will be.” (Mark Lamberti of
Massmart) (1st, page 59)
Robert Shiller’s book “Irrational Exuberance” explains that
humans punish themselves for doing the wrong thing so tend to
sell winning stocks too soon to avoid the pain of losing later and
hold onto losing stocks to avoid making paper losses real.
Investors do not learn from their mistakes as they do not want to
admit that they made them in the first place. (The answer is to
base investment decisions on well-researched facts using a
scientific model that crystallises value from the views formed.)
(15th, page 38)
With reference to the Hefer commission, if journalists allow
themselves to be unduly influenced, they lose the right to protect
their sources. (The view of the editor.) (22 nd, page 4)
Mark Shuttleworth says that it is ironic that entrepreneurship,
regarded by Government as the solution for the creation of muchneeded jobs – is hampered by red tape. (Anybody out there
listening?) (22nd, page 4)
And talking about red tape, the JSE is to embark on a sustainable
development-reporting project that will result in a sustainable
reporting index (SRI). This index will provide a scorecard for the
three elements of the triple bottom-line, environmental, social and
financial sustainability. The levels of compliance will be policy
and strategy, management systems and performance reporting.
The work in collecting the data will be outsourced and to qualify
for the index a company must achieve an overall score of at least
70. (One day we will realise that a successful business is one that
The labour court in Durban ruled that employees are entitled to
accumulate leave if the employer does not insist that the employee
take leave. (This has repercussions on the leave pay provision. If
it affects you, get hold of the details. I was told that there were
special circumstances in this case that lead to this judgement.)
(29th, page 8)
Fortune
“The big four auditing firms have been fighting off one publicrelations crisis after another. There’s a good reason: They keep
starting them.” The article goes on to list the problems PwC are
having with MicroStrategy and Tyco, E&Y’s destruction of
documents relating to the audit of a consumer loan company,
KPMG for problems at Xerox and D&T for failing to notice that
the founders of Adelphia were looting the company of Billions of
dollars. And all four are facing litigation from wealthy clients
who bought into complex and possibly illegal tax shelters. The
auditing profession has been complaining that it cannot make
money from auditing. They have the best franchise in the world,
clients have to buy their services and no one else can offer them.
How much better can it get?
(When greed surfaces,
professionalism drowns.) (13th, page 81)
When it comes to saving for your retirement, it’s not what you
know but rather what you do with what you know. Retirement
planning is an action sport. Your portfolio requires hands-on,
disciplined and very regular maintenance to grow as it is supposed
to. The problem is that most people are either paralysed by the
sheer number of options or too intimidated by the market to
engage. (How true. Do not neglect this aspect of your life.) (27th,
page 79)
Noseweek
Dear Noseweek, I am a small-town chap that tends to get to the
truth. I am often drawn into messy confrontations. Whom do you
use for legal support? I’d also be interested to know how you
handle the reactions emotionally. Telling the truth can be
draining. El Cid
Dear El Cid, Do you want to sue or are you being sued? Are you
rich? Whichever, my best all-purpose advice is to stay away from
lawyers. Talk/negotiate your way out of the mess yourself. You
know the facts better than they do. You know what you can
afford. Be humble. Even take a loss – it will be smaller and less
humiliating than the loss you will most certainly suffer at the
hands of your own, let alone your opponent’s, lawyers. You owe
us a lunch. Noseweek
Dear Noseweek, You did not answer the second part of his
question. CPH.
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Mafia Buzz 2003
Techtalk
The following two EDs have been issued for comment:
164: Disposal of non-current assets and presentation of
discontinued operations.
165: Insurance contracts.
The IASB is getting involved in accounting for SMEs. They
should stick to what they know, and that is focus on setting
standards for general-purpose financial statements. I am going to
guess that RSA will follow whatever they say and we will be
burdened with complex accounting standards for private
companies. It is really time for the Government to step in and put
a stop to this madness.
Auditing EDs on (1) The auditor’s responsibility to consider fraud
in an audit of financial statements (ISA240) and (2) Planning an
audit (ISA300) were published for comment – see the PAAB’s
website.
IFAC has recommended changes to its code of ethics and is
suggesting that the code becomes a standard.
IFAC has published a document called “Rebuilding public
confidence in financial reporting: an international perspective.”
If you are into public sector accounting, read pages 26 and 27.
The August issue of Integritax looks informative. Do you
download and read this on a regular basis? I must admit that I
have been neglecting this aspect of my education. You can get it
on www.saicacolleges.co.za. (Who would have thought that this is
where to find it!) By now they should have their tax website up
and running.
November 2003 (30 Minutes)
Accountancy
BDO Stoy Hayward’s former Nottingham office, now Tenon, was
given the largest ever fine by the ICAEW for signing an
unqualified audit report for Princedale Group plc. Part of the
problem was to do with derivatives. (Page 5)
E&Y are being sued because they did not warn a life company
about the consequences of offering guaranteed pensions! (Add to
your audit programme: “Evaluate every management decision for
stupidity!”) (Page 10)
Sir David Tweedie says that practitioners must not ask questions
of the standard setters because this will reduce the standards to a
rules-based system as happened with IAS39. (How can one apply
wishy-washy principles without guidance? The result will be that
everybody will do his/her own thing and GAAP will become a
joke.) (Page 16)
When involved in a turnaround, one needs to think carefully and
slowly but act fast. Instead of taking the easy route of cost
cutting, one should work on revenue enhancing measures. The
trick is not to get caught up in the crisis. (Page 25)
The professional institutes, which were once seen as authoritative,
are now being seen as mouthpieces for the large audit firms. The
Economist believes that US regulators are too ready to listen to
auditors and are therefore not taking the action that should be
taken to rectify the abuses that have been taking place. (Page 26)
The ICAEW is considering a plan to force all members to make
the effort to think through what continuing professional
development (CPD) activities they should be carrying out. They
expect to finalise the plan by next summer. (Mr. Editor, do you
not know that there are people in the Southern Hemisphere that
read your journal? Or do you think that summer happens in both
hemispheres at the same time?) (Page 49)
Internal auditing should not operate on the fringes of an
organisation but should be risk-focused, evaluating the enterprisewide risk management (ERM) of the organisation. However,
internal auditors should be careful not to cross over to a
management decision implementation role. (Page 50)
Dennis Oswald and Steven Young did a survey to discover what
motivates companies to buy back their shares:
1. To pay out cash surplus to the company’s needs.
2. To buy the shares when the price is low.
3. To optimise gearing (in RSA if you borrow to buy back
shares you may not get the interest paid as a deduction).
4. To counter the dilutive effect of issuing options to staff.
5. To boost the company’s earnings per share.
6. To not be seen as empire building.
7. To improve the return on equity (this is my point).
(Page 54)
Deloitte Touche Tohmatsu, and all the other names this firm goes
by, has re-branded itself as Deloitte☻(without the face in the
black dot. And please also note that the colour of the dot is not
black either, it is green.) (Page 64)
99,2% of companies in the UK are not listed. And IFRSs are
primarily designed for quoted companies! (Now we can’t let all
this hard work be used for only 0,8% of the market, can we? So
let’s see if we can’t apply it to SMEs as well!) The IASB has
formed an SME division. (The mistake that they are making is
that they think that SME managers use financial statements to
make decisions. They don’t. Financial statements are usually
prepared long after any decision has to be finalised. Managers use
internal financial reports to make decisions that do not have to
comply with screeds of accounting and disclosure standards. The
IASB should focus on preparing standards for general-purpose
financial statements and leave over-regulated SMEs alone.) (Page
80)
Ron Paterson debates the ED on discontinued operations, i.e. the
problems of:
1. When to make the provision for any loss on closure.
2. The conditions for disclosing discontinued operations.
He concludes that it is not necessary to have a statement on this
topic as other standards, such as impairment, deal with the first
problem and the second problem can be dealt with in segment
reporting. (Page 87)
The ICAEW has published guidance on prospective financial
information (PFI) disclosure by companies. The guidance
emphasises that markets and investors will find PFI useful if it
follows the principles of (Page 89):
1. Reasonable disclosure – understandable to the general user.
2. Business analysis - faithfully present actual strategies, plans
and risks.
3. Subsequent validation – can be compared with outcomes.
Roger Smith believes that the increased turnover threshold of ₤5,6
million is a huge leap in the dark. He says that auditors do not
seek to block a reduction in regulatory costs for SMEs because of
self-interest. They support the retention of statutory audits where
there is a public interest and where the benefits outweigh the costs.
He feels, however, that this move will increase the risk of
companies not complying with various laws. (Page 91)
The objective of analytical review is to answer the question: “Do
the numbers make sense?” AR is done at the planning,
substantive testing and review stages of the audit. The objectives
of the tests, methods used, results and conclusions reached should
be documented. The procedure should embrace the following
stages:
1. Predict – what result is expected from the test
2. Calculate various ratios and relationships
3. Compare actual results with predicted results
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Mafia Buzz 2003
4. Enquire – get explanations for deviations
5. Corroborate with management explanations
(All straight out of SAS410.) (Page 92)
One has to question a statement of GAAP that is so rigid and
prescriptive that it makes accounts incomprehensible and
interferes with a company’s ability to do business and deliver
value to its shareholders. (Three guesses which AC they are
talking about?) (28th, page 12)
Accountancy SA
See December.
Business Day
The first successful conviction in a criminal prosecution for
insider share dealing has taken place. The fine was R100 000!
(The message sent by this sentence is that crime definitely does
pay in RSA.) (6th)
Two interesting adjustments to headline earnings appeared in the
unaudited accounts of Beige:

Recovery of restraint undertaking payment

Liquidation dividend
In his book “Good to Great” Jim Collins describes the “doom
loop”. This is when a company implements big programmes and
radical changes, restructures, looks for a miracle moment or new
saviour, tries to align and motivate people to its new vision, sells
the future to compensate for a lack of results and embarks on a
new radical path. (Sounds like some companies you know? SA
Rugby Incorporated?) (25th)
Trustees of pension funds, with the assistance of investment
advisors, should set the allocation and risk policies of the funds
they administer. Tactical asset allocation, which is the up
weighting or down-weighting of asset classes, is a function of
asset managers. Many trustees are not suitably qualified to set
strategic asset allocation. They need to educate themselves and
seek advice. (30th)
A fight has broken out between SAICA and the ministerial panel
reviewing the accounting profession regarding the examinations.
The review panel is suggesting that we go back to writing part 1
and part 2 of the QE soon after qualifying at university. SAICA
says that this will reduce the standard of the CA (SA)
qualification. (31st)
Business Day Management
Tony Balshaw, partner-in-charge of family controlled companies
at Grant Thornton Kessel Feinstein compares the family system of
running a business (emotion based) with the business system (task
based):
Emotion Based
Inward looking
Express feelings
Caring
Protect low achievers
Averse to change
Risk-averse
High dividends
Family leadership succession
Recruit family first
Equality
Wealth preservation
(This really strikes a chord!)
of Citigroup suggested to me recently that the systematic risk
premium that I use in my discount rate to value shares should not
be fixed at 6% but should be a factor of the risk free rate.)
Task Based
Outward view
Unemotional
Reward performance
Perform or leave
Embrace changes
Risk taking
Reinvest capital
Best person for the job
Best qualified applicant
Meritocracy
Wealth creation
Citizen
John Loots, Absa’s economist, says that there is a realistic chance
that gold could hit $500 an oz (when?) and that the rand could stay
at R6,50 for the next two years. (27th)
Financial Mail
Raymond Ackerman describes inflation as “A thief in the night.”
Jacko Maree says that it is harder to earn a real return of 10%
when the inflation is 3% than when it is 20%. (Rhys Summerton
Finance Week
Naspers will not disclose its provision for leave pay because
management will then have to explain to shareholders how it grew
to such large proportions. (So, dear shareholders, you now know
what question to ask at the next shareholders’ meeting!) (5th, page
15)
Investors should ask the following questions to help them identify
current and future growth shares:
1. Did the company show strong historical growth?
2. Will the company show strong earnings growth in future?
3. Is management in charge of income and costs?
4. Can management manage the enterprise effectively?
5. Is the share price in the buying zone?
6. Can the share price double over the next five years without
an adjustment in its PE ratio?
(Would we not all be wealthy if we could look into the future like
this?) (12th, page 42)
A thought from Vic De Klerk’s story on diluted earnings: Take the
difference between headline earnings and diluted headline
earnings and multiply this difference by the PE ratio to get the
value of the company given away by the directors. (Just a thought
that one can develop further.) (19th, page 20)
Stafford Thomas says that cash flow does not lie and one should
look carefully at operating cash flow after tax and working capital
but before capital expenditure and dividend payments when
assessing a company’s performance. (ST, my mate, did you not
follow the Worldcom story? It is the easiest thing in the world to
fiddle cash flow: debit plant and credit operating expenses.) (19th,
page 47)
The number of companies listed on the JSE is shrinking. One
possible explanation is that the JSE is becoming too strict with
their compliance requirements. (I recently advised a company to
delist because of the petty attitude of the JSE regarding technical
faults in the financial statements of the company.) (26th, page 4)
In similar vein, Mark Hasenfuss says that the JSE must walk a
tightrope between nurturing the entrepreneurial spirit and
regulating the market. (They could achieve this by coming down
hard on deceit and not harassing companies because of technical
contraventions.
They should have a policy of educating
companies rather than disciplining them at least until the new
GAAP has been understood by all.) (26th, page 17)
Sunday Times
Statistics released by SAICA show that 19 948 of the 21 819
qualified chartered accountants are white. Only 397 are black,
254 coloured and 1 172 Indian. (48 are not sure what they are.
Maybe they are South Africans?) (30th)
Instead of motivating the (Springbok) team and turning them into
winners, all the camp did was to reduce them to fumbling
psychological wrecks, unfit for anything except public mockery.
(Well said Dave.) (While investigating the training methods of
the Boks, they should have a look at the preparation of the SA
cricket team prior to that world cup – same mindset?) (30th)
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Mafia Buzz 2003
December 2003 (30 Minutes)
Accountancy
The audit threshold in the UK has been increased to ₤5,6 million
turnover. This takes 69 000 companies out of the audit system. It
will enable SMEs to cut costs, lighten the regulatory burden and
get on with the task of making profits (paying more taxes) and
creating jobs, and generally being able to be more competitive.
(We should be so lucky in RSA!) (Page 5)
KPMG could have cost the US taxpayer $10 billion by selling a
product involving tax shelters via telemarketing. (Page 6)
The Association of Corporate Treasurers has slammed the IASB
for its stand on financial instruments. It believes that this standard
will have a major negative impact on treasury best practice in nonfinancial sector companies. It says that the IASB is a one way
street – it is impossible to get them to respond to comments.
(Companies I lecture to are looking for a sponsor to take up the
cause in RSA. But, we are a bunch of sheep here and accept
anything that anyone in authority throws at us.) (Page 16)
The auditors of the EU have, for the 9th year, qualified the EU’s
financial statements. They say that they can give assurance on
less than 10% of the annual budget! (Page 16)
Enron and WorldCom have seriously undermined the reputation of
US business, and represent a fundamental betrayal of American
investors. The public sees a rigged game of insiders and the
privileged. So says the chairman of SEC, which is to boost its
enforcement staff from 3 200 to 4 000. (Page 18)
Most audit practitioners of SMEs do not feel threatened by the
move to increase the turnover threshold to ₤5,6 million. They say
that the audit element in professional fees is not material to their
practices. The feeling in Government is that the new regulations
on money laundering will reduce the need for audits. The problem
is that accountants will now have to report fraud and not get paid
for doing so. (Page 22)
Robert Bruce says that due process in the US rids business of
innovation and imagination. He feels that such processes spawn
corporate scandals. (Not sure about the link here!) He is sad to
see that the EC has insisted that they need a system of due process
to endorse the IASB accounting rules before enforcing them. This
slows down the process and leaves everyone in limbo. (SMEs in
RSA can empathise with this – differential reporting.) (Page 23)
Chris Swinson asks “if shareholders are prepared to neglect their
role as owners, who is there externally to hold the boards to
account?” He says that legislation cannot ensure that shareholders
act seriously as owners. (Page 26)
If you are involved in Charities, get hold of the articles from pages
28 to 36 (not from me - SAICA’s library will help). There are
some excellent ideas in these pages.
Ian Livingston, hot shot FD of BT, says that success is one part
strategy and nine parts execution. He says that lots of people are
good strategists but they don’t do the execution very well. (Page
37)
People think that corporate scandals are exclusive to the US and
that US GAAP is to blame. They seem to forget the UK’s
Maxwell, Polly Peck, BCCI, Caparo, etc. And, now, wait for it,
SSL International, the makers of Durex, overstated sales and
profits by ₤25m for the two years ended March 2000. There is a
worry that the company may not be able to meet its debt
repayments of ₤400m. (Page 46)
Almost half of SMEs surveyed admitted to having only a few
honest persons in their employ. The potential risk areas are staff
(45%), purchases (19%), sales (13%) and financial reporting
(10%). (Page 73)
The ICAEW is on another mission to improve business reporting.
They want to examine how a reporting framework can be created
that fulfils market needs for truly useful information. Although
financial accounting was invented to be useful, this objective has
largely been forgotten. The Corporate Report was published in
1975 (a brilliant document). Much of what it recommended was
never followed up. The value-added statement did catch on but
has been largely abandoned today. One of the downfalls of
previous attempts has been to try to satisfy a wide range of users.
However, they should realise that only investors count and the
focus should be on meeting their needs. Other users can interpret
this information to satisfy their own needs. (Page 79)
The ICAEW has published the first and second reports in a series
to encourage improved information reporting:
1. Prospective financial information: guidance for UK directors.
2. New reporting models for business.
Reformers believe that financial reporting information is both
misleading and inadequate. They want extensive disclosures of
non-financial, qualitative and forward-looking information. Go to
www.icaew.co.uk/bettermarkets where you can get further
information. Issues covered in the second report are:
1. Whose needs should be addressed?
2. What decisions are being made based on these reports.
3. Whether the market will reward good disclosure.
4. Whether the conceptual framework is valid.
5. What to do with intangibles.
6. What level of transparency is applicable? (Page 80)
The IAASB has released the following new standards:
1. Objective and general principles governing an audit of
financial statements. (ISA200)
2. Understanding the entity and its environment and assessing
the risks of material misstatement. (ISA315)
3. The auditor’s procedures in response to assessed risks.
(ISA330)
4. Audit evidence. (ISA500)
These standards replace the existing ISA 200, 310, 400, 401 and
500. They can be downloaded from www.ifac.org/store. (Page
81)
PwC discusses the implications of IFRS 1 (first-time adoption of
International Financial Reporting Standards) regarding financial
instruments. This should not be a major problem in RSA as we
adopted AC133/IAS39 last year. However, we will need to study
the new version of IAS39 to see what first-time adoption
consequences there will be. (Page 82)
Ron Paterson considers the new publication of the official text of
accounting standards for 2003-2004. It weighs 1,75kg and runs
into 2 534 pages. He says that it has become so voluminous and
complex that it will leave much of the profession behind. Many
accountants do not get round to reading the standards. Those who
do tend to find the language impenetrable and the concepts elusive
and counter-intuitive. He ends by stating that if we need
thousands of pages of dense verbiage, it shows that the standardsetting process has gone off the rails. (Page 84)
The IASB is considering the “wholesale approach” for the
recognition of revenue. This will involve valuing a sales contract
at what you can get someone else to perform it for and taking the
difference to income immediately! (This will truly be the final
nail in the coffin of IRFSs!!) The ASB prefers the “retail
approach” where the profit is only taken when the seller has
performed in terms of the contract. (Page 87)
Here are some ideas for developing leadership traits:
1. Develop intuition – gut feel.
2. Think creatively – seek experiences to trigger it.
3. Act decisively and consistently.
4. Pay attention to others – listen intently.
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Mafia Buzz 2003
5. Ask open powerful questions.
6. Hold others accountable.
7. Create and communicate a vision.
8. Provide meaning for people.
9. Express things in simple clear ways.
To achieve the above, adopt a cyclical process of plan-do-review.
(My cyclical process is facts-think-plan-do-review.) (Page 112)
Accountancy SA
Bay Jordan says that people in an organisation are important.
(Wow!) (Page 4)
Harmke Immink and Donnė Sephton summarise the practical
problems with emission rights (e.g. the Kyoto Protocol) and give a
good summary of the ED on the topic (which I think is crazymad). (Page 7)
Izėl du Plessis discusses the proposed regulation of tax
practitioners. (I don’t know about you but I am getting very
irritated about big daddy taking control of every aspect of our
lives! My dear Godfather has asked me to wind up his estate (he
is thinking of dying). Are they going to make me join a special
society and take special examinations to help a relative out? Soon
I will risk jail time if I give my wife investment advice!) (Page 9)
Graeme Tosen summarises the formulas and measures for call and
put options. (If you did my valuation workshop you will find the
formulas and measures in the last valuation model on Excel.) I
have another stupid question Graeme: Why is the projected
dividend not part of the formula? This could make quite a
difference when the time period is long. (Page 10)
Tom Theron deals with the financial management problems in the
public sector and what can be done about them. (Page 14)
My article (please read it) deals with horror valuations I have seen
in practice. (Page 26)
Citizen
Saddam Hussein has told coalition forces of the whereabouts of
some $40 billion (R280 million) he stashed abroad. (Whew, the
Rand really has improved this month!) (30th, page 9)
Finance Week
Deon Basson, criticised Investec/Fedsure for not separating the
policyholder investments from those of the investors. He implies
that the policyholders lost out to the shareholders. In the same
journal Investec counters with a statement saying “Not true.”
Who knows where the truth lies? Maybe this is a lesson for the
insurance companies to better explain their results in their
financial statements. (3rd, page 8)
Financial Mail
Freddie Mac, the second largest US mortgage financier, was fined
$125 million for inflating reported earnings for the past three years
and Parmalat, the Italian food giant, overstated its cash and cash
equivalents on its balance sheet by over 4 billion Euros. (When, if
ever, will this stop?) (19th, page 8)
Fortune
When analysts join Vanguard, a US mutual fund, they receive a
mouse-pad with a message: “Serve as a role model for the
industry by adhering to the highest standards of ethical behaviour
and fiduciary responsibility.” Even Senator Peter Fitzgerald, who
called the mutual fund industry the world’s largest skimming
operation, endorses this fund.
(The problem with ethical
behaviour is that it is much more difficult to make money – this is
why the easy route to riches is to be a cheat.) (8th, page 24)
Robert Rubin, former Treasury Secretary in the US, has an
interesting philosophy. He says that everything is open to
analysis. There are no provable absolutes, no givens. One needs
to assemble every available fact and then weigh the odds before
taking decisions. He calls this “probabilistic thinking”. (8th, page
44)
The questions you should ask before buying equities are:
1. How does the company REALLY make its money?
2. Are sales and growth therein real:

How aggressive is the accounting policy for revenue?

How is service revenue recognised?

What is the relationship between cash from customers
and sales?
3. How is the company doing relative to its competitors?

Are the post-retirement obligations killing the company?
4. What is the impact of the broader economy on the company?

Effect of interest rates, foreign exchange rates, GDP,
etc.?
5. What could really hurt or kill the company over the next few
years?

Type of business a problem?

Financial strength (liquidity and solvency)?
6. Is management sweeping expenses under the carpet?

Restructuring charges occur regularly?

Expenses are capitalised to assets?

Irregular costs occurring regularly?

Stock options issued regularly undermining wealth?
7. Is the company living within its means?

Is the debt/equity ratio within norms?
8. Who is running the company?

Does management change its policies regularly?

Does management have stock excuses for poor results?

Does the company sport spanking new offices with lifts
going through fishponds?
9. What is the stock really worth?

Use CPH’s wonderful valuation models!
10. Do you really need to own this stock? (Page 58)
Maneo
A summary of the main recommendations coming from the
Review Panel on the Draft Accountancy Professional Bill is:
1. The legislation should focus on auditors and not the broader
accountancy profession.
2. A new body should replace the PAAB, which should have a
particular public interest perspective and focus.
3. The members of the new body should include all relevant
interested parties.
4. Funding for the new body should come from Government.
5. The functions of the new body will be similar to those of the
PAAB, but with more independence.
6. The disciplinary powers of the new body would be enhanced.
IFAC has issued two EDs, Fraud in audit and Audit planning.
The ASB has issued SAAPS1014 Reporting by auditors on
compliance with International Financial Reporting Standards.
SAICA has issued the following:
1. Guidance for auditors: reporting on attorney’s trust accounts.
2. Corporate governance guide: audit committees for medical
schemes.
3. Guidance for auditors reporting in terms of the immigration
act.
The IAASB has issued the following:
1. ISA315: Understanding the entity and its environment and
assessing the risks of material misstatement.
2. ISA330: The auditor’s procedures in response to assessed
risks.
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Mafia Buzz 2003
3.
ISA200: Objective and general principles governing an audit
of financial statements.
4. IAPS1005: The special considerations in the audit of small
entities.
Practice review is moving into its third review cycle, which will
focus on placing greater emphasis on high risk assignments in
order to address the concerns of the public interests. Jillian sets
out details of the programme, which commences in January 2005
(time to get your act together). It is good to see that priority rating
is part of practice review’s strategic thinking.
The disciplinary committee has been extremely busy taking
practitioners to task. Here are some of the naughty things that
were attacked:
1. Using a refund from SARS to set-off the practitioner’s
outstanding fees (what a great idea!) (Joking!).
2. Not supervising staff.
3. Not responding to correspondence (GOOD – see below).
4. Not obtaining an engagement letter.
5. Not reporting a material irregularity.
6. Saying they did not do an audit when they did.
7. Inadequate planning documentation.
8. Inadequate documentation to indicate that risk was assessed.
9. No proper evaluation of internal control.
10. Various examples of insufficient audit evidence obtained.
11. Failure to submit income tax returns, to deal with tax queries
and to inform the client of tax arrears.
12. Not notifying a client to stop paying debit orders once the
outstanding fee was settled and refusing to repay the excess
received immediately in full.
13. Not informing the executrix of an estate of progress being
made in the winding up of the estate.
I am really pleased about number 3. South Africans need to be
more polite. You will not believe how often I go the extra mile
for someone only to be rewarded with silence.
Techtalk
The objective of ED167 is to convert the following AC statements
to IAS standards (I suggested this seven years ago!): AC 000, 100,
102, 109, 111, 114, 115, 116, 118, 119, 120, 121, 124, 127, 130,
134, 136 and 137. (Note that there is no IAS equivalent to AC121
at present. They are busy working on insurance contracts.)
AC138/IFRS1, first time adoption of IFRSs, has been published.
ED166, which dealt with hedge accounting for a portfolio hedge
of interest rate risk, was published. It is now part of IAS39.
ED168, which dealt with the transitional provisions for
impairment of loans and receivables on the initial adoption of
AC133 was published. (They got it wrong!)
ED169, dealing with changes in decommissioning, restoration and
similar liabilities was published for comment.
On the auditing side the following have been published:
SAAPS1014: Reporting by auditors on compliance with
international financial reporting standards.
A new preface to international standards on quality control,
auditing, assurance and related services by the IAASB.
An ED on ISA300 – planning the audit
Other matters covered are developments in the public sector, tax,
exchange control amnesty and the reporting by CAs in terms of
the Immigration Act. (How in heaven’s name does a small
practitioner keep up with all this every month and still try to give
clients a service? In the last month, two of my friends in public
practice have sold up because they can’t keep up!)
Tax
Taxgram
The Supreme Court of Appeal in the Warner Lambert case held
that the Sullivan Code expenses are incurred in the performance of
the taxpayer’s income producing operation and are, therefore,
deductible expenses. (September 2003, issue 8)
If an amount owing to creditors is not claimed and transferred to
profits, this amount will be included in taxable income. If the
creditor makes a successful claim at a later date, then the amount
will be allowed as a deduction. (September 2003, issue 8)
SA Tax Cases Reports
Two brothers sold their shareholding in a trading company to a
trust for R380 000, as valued by the auditors. SARS placed a
valuation of R3,3 million on these shares and hit the brothers for
donations tax on the difference. The judge’s comments on the
valuation were: “The auditor’s valuation was patently not
reflective of the fair market value, of which fact he could not but
have been aware. His claim that he was instructed to determine
the fair market value and in fact did so, simply did not wash and
he resorted, for obvious reasons, to the lowest possible valuation
that he thought would pass muster.” (Two questions: Does this not
amount to bringing the profession into disrepute? Is this what we
can expect when CGT becomes payable? The answer to both
questions is clearly “yes”.) (Volume 65, part 4, 2003)
Noseweek
In the past I have been terrified of being sued if I quoted from this
source but there is an important lesson to learn in the article on
page 28 of the November issue. A company received a large
payment in error. The owner claims to have asked his lawyer
what to do and was told to place it on call. He was told that any
interest earned would be his to keep until the money was claimed
back. The money never ended up in a call account but was used to
pay the company’s creditors. The company has now been placed
in liquidation. Question: “Why did the owner have to ask his
lawyer what to do?” Clearly if you receive something that does
not belong to you, you go out of your way to give it back. If you
don’t, you are a thief.
CFA Magazine
The AIMR has commenced the publication of a bi-monthly
magazine from which I will be quoting in future.
May/June 2003
Tom Bowman, AIMR President and CEO (they know nothing
about the King Report!) says that the standard setters are now
(after the Enron and WorldCom affairs) keen to entertain the
perspectives of the users of financial statements. (With respect,
my friend, the users have never been interested in standard setting
in the past – they have been too busy making money!) He is
encouraging users to get involved. (Page 3)
The following criticisms have been raised against expensing
options:
1. The cost that never was gets cancelled out by crediting
equity.
2. Options affect the number of shares and not the economic
income of the entity.
3. Diluted EPS accounts for options already – no need to
duplicate.
4. Analysts’ models already account for options in the
valuations. (Page 4)
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Mafia Buzz 2003
The original concept of a hedge fund was to go long on undervalued securities and to go short on over-valued securities. They
funded their long positions by borrowing, hence the name. 14%
of hedge funds in the US closed down last year compared to 4% of
mutual funds. When investing in a hedge fund, one is really
investing in the management of the fund.
(They should
differentiate between “investing” and “speculating”. Note: “long”
means “hold” and “short” means sell something you don’t own.)
At last investment performance in the US is now being measured
on an after tax basis. (We just need to get the standard setters to
understand that tax is an expense in their standards.) This
becomes complicated in the US as different states have different
tax rates, e.g. tax in California is 9% compared to 3% in Illinois.
(Page 13)
The AIMR supports fair valuing of financial instruments in the
financial statements of companies as this makes the financial
statements more transparent and relevant. (But does it make them
more reliable?
I have seen many cases in RSA where
management have a field day attaching values to financial
instruments to meet their own agendas. Note that the concept of
value is “exit value”, i.e. what the company could get for the asset
if it sold it at the balance sheet date. (Why then ignore selling
costs?) (Page 17)
A fund manager questions whether the threat of being audited by
SEC will stop fraud in the hedge fund industry. “I haven’t seen
how the threat of audit by the IRS has stopped tax cheating!”
(Page 25)
Fair value accounting becomes a joke when you have to place a
value on an OTC (over the counter) path determinant binary
option! (Page 43)
When one evaluates returns it is instructive to measure the Risk
Adjusted Return of Capital (RAROC) of that investment. A
corporate bond may, for example, give a return of 4% p.a. whereas
an investment in a hedge fund may give a return of 20%.
However, if the value-at-risk (VAR) at a confidence level of 95%
for the bond is 10% and that of the hedge fund is 80%, the
RAROC of the bond would be 40% (4%/10%) and that of the
hedge fund only 25% (20%/80%). This might make one think
twice about going for the hedge fund “investment”. (Page 43)
July/August
There is a massive investigation going on at present in the UK on
soft commissions. The way it works is: The broker gets orders
from the fund manager, executes the orders, charges brokerage for
the service and then passes as much as 40% of the brokerage over
to the fund manager in a disguised form, e.g. buying computer or
computer supplies for the fund manager. The fee charged to the
client is therefore not a true reflection of what the fund manager
earns. This has real potential for fund managers to churn
portfolios to generate soft fee income. The practice is, at last,
under attack by the authorities. (Pages 3 and 19)
Should one invest in under-performing markets purely to reduce
portfolio risk? I have always believed that the focus should be on
maximising returns. Agreed, you must look at the risk but it
seems crazy to invest in a falling investment merely to reduce
portfolio risk. (Page 5)
The debate is heating up on quarterly reporting at the EC. The
main argument for quarterly reporting is to align with US
reporting. The main argument against is that it will encourage
short-term thinking and actions by management. No one seems to
have looked at the disruption in the companies themselves. No
sooner have you got the last quarterly financials out, you will be
working on getting the next lot out. What compensation will there
be for the company for the additional costs incurred? (Page 18)
1.
The Act calls for full details of all off-balance sheet
transactions,
arrangements,
obligations
and
other
relationships of the issuer that could have a material impact
on the company.
2. Non-GAAP disclosures, such as EBITDA, must be tied back
to a GAAP measure and a statement by management
explaining why such disclosures are beneficial to investors.
Companies will not be able to label obvious recurring writeoffs as “non-recurring”.
3. Directors with a 10% or higher holding in the company must
disclose within 2 business days of the transaction, details of
any purchases or sales in the shares of the company.
4. Companies and their subsidiaries may no longer make loans
to directors or top managers. (Page 20)
The problem with the US approach to standard setting is that they
write as many rules as they can and demand that accountants don’t
break them. The glaring deficiency is that if it’s not prohibited,
it’s okay. What sets the US apart is their strict enforcement. (I
wonder if this is not why we get more scandals in the US? They
find them. Other countries allow them to go on undetected.) (Page
23)
September/October
Malaysia supports little gaap for little companies. The AIMR is
against having a two-tiered approach. They want big GAAP to
apply to all companies. (Why would they want a butcher to pass
eight journal entries when she imports meat from the US when
two would do? Let’s keep big GAAP for general-purpose
financial statements and let’s leave small companies to get on with
the task of creating jobs, making profits and paying taxes.) (Page
19)
The rest of this bi-monthly journal is devoted to the behavioural
aspects of investing. Here are some ideas I captured:
1. Keynes said that picking stocks is like a beauty contest – the
judges must decide on not only who is the most beautiful but
whom everyone else will think is most beautiful.
2. Cognitive bias is the tendency of intelligent, well-informed
people to do the wrong thing.
3. Attention grabbing stocks do not outperform the market.
4. Know the intrinsic value of a share. This way one can
determine to what extent behavioural factors are built into its
price.
5. There is no evidence that behavioural finance techniques can
enable an investor to make money on stocks. (But I believe
that a knowledge of this technique can reduce the risks of
losses.)
6. A stock is not necessarily a good buy just because the
company is sound. The price of the stock may be inflated.
7. Just because you know that the market is undervalued you
can’t make money on it right away – you can’t trade against
sentiment. (Ever tried waiting?)
8. Familiarity bias is where we believe that things that are
familiar to us are better and less risky – this is why so many
people put so much of their money into the stock of the
company they work for, e.g. the poor staff of Enron.
9. The brain uses shortcut methods to make financial decisions
without having to do the full analysis.
10. We tend to hold onto loss making shares as we do not want to
admit that we made a mistake.
11. We tend not to like boring companies when they can make
sound investments.
12. We tend to be overconfident in our decisions (overconfident
bias).
13. We focus on information that confirms our beliefs and ignore
inconsistent information (confirmation bias).
14. We tend to place too much emphasis on similarities
(representative bias).
Three aspects of SOX are discussed:
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Mafia Buzz 2003
15. We tend to anchor estimates to salient numbers even if the
figures have little or no relevance to the estimates (anchoring
bias).
According to Kenneth Fisher, category picking is far more
important than stock picking. (Page 43)
To expect people to make wise decisions in their defined
contribution plans is asking too much. Participants usually lack
investment education, display all the wrong behaviour patterns, do
not have enough time (or incentive) to allocate to the problem and
are too busy in their jobs to think about it anyway. They do not
save enough to cater for their retirement. An interesting idea is
the Save More Tomorrow Plan (SMTP) where participants
commit in advance to allocate a portion of their future salary
increases toward retirement savings. Inertia takes over and
participants tend to stick to the plan. (Page 45)
One of the most effective means for dealing with poor behaviour
patterns is to write out a thorough investment policy statement and
stick to it. The statement should be specific, i.e.: Why are you
saving this money? What do you want to buy? When do you want
to acquire it? (Page 51)
November/December
The total sum of all the advisory fees, marketing expenditures,
sales commissions, brokerage commissions, transaction costs,
custody and legal fees and securities processing expenses (and
audit fees?) come to $300 billion a year in the US. This is nearly
3% of the total capitalised market value of $12 trillion. So the
mutual fund industry confiscates nearly 50% of the historical real
rate of return earned on the market. (It would be interesting to
compare this in RSA were we do not have the same economy of
scale as in the US.)
75% of analysts worldwide say that financial information provided
by companies is extremely or very important to their investment
decisions. Those who use this information are disappointed by the
quality of it. Companies should distinguish themselves by
improving the disclosures they provide. (Page 10)
Every company wants to establish a strong track record earningswise. However, it becomes messy when companies start overmanaging expectations. (Page 11)
Burton Malkiel of A Random Walk Down Wall Street fame says
that 66% of professionally managed portfolios are beaten by lowcost index funds. The third that beat the index in some particular
period are not the same as those that beat the index the next
period. (Page 29)
Professionals act not to make the most efficient risk-adjusted
return but to protect their careers. (Page 31)
The equity risk-premium is not a fixed number but varies through
time with market conditions, with demographics and with all sorts
of phenomena that are determined by evolutionary forces. (Rhys,
you will like this!) (Page 38)
The valuation evolution started at earnings, marched up the
income statement to EBITDA (which ignores some expenses) and
finally ended at revenue, thereby ignoring all expenses! EBITDA,
pro forma earnings, eyeballs and hits have largely been
discredited. The raw materials of valuation models still depend on
the quality of the financial statements. The problem is that
creative accounting makes it difficult to value companies. There
are, however, methods to catch this sort of thing, (Page 40)
Standard and Poor have found that over one and three year periods
ending 312 March 2003 18 out of 26 active managers did not beat
the corresponding indexes. (69%, which correlates to the other
survey above.) Some active managers beat the market because
they take outlandish risks. (Page 44)
Mellon Capital Management uses enhanced indexing to manage
its portfolios. It is well diversified across various economic
sectors and over weights stocks that it believes will do well, based
on fundamental analysis. (A sound approach.) (Page 45)
Stephen Dillenburg of Summit Investment Partners says that it is
not fraud that causes inefficient pricing but the market’s failure to
detect it. He uses the cockroach theory that says: “If you find one
cockroach in your home, you know there are more.” The signs at
Enron were:
1. Excessive CEO compensation.
2. Excessive dilution of shareholder value through staff options.
3. Dominant inside directors on the board.
4. Pandering to the financial analysts.
Many knew that Enron had problems but chose to ignore them.
Even though information is knowable and solid, it does not mean
that people will take notice. Even insiders, who were party to the
deceit, ignored the events and maintained their holdings in their
pension fund portfolios! (Page 52)
What You Always Wanted to Know But …
The Shady Side of Fund Management
The following terms are used in describing the shenanigans that go
on in fund management:
Market timing: Trading in and out of mutual funds to make a
quick profit.
Late trading: Buying or selling shares of a fund at a given day’s
price after the usual close to enable to allow investors to act on
after hours developments that could move prices.
Front-running: Trading stocks or bonds ahead of a mutual fund
when you have information that the fund is about to buy or sell a
particular counter.
Scalping: When a portfolio manager uses mutual fund assets to
buy a stock to jack up its price when he already owns it in his
personal account.
Cloning: Setting up a special brokerage account to conceal an
investor’s identity thus helping him avoid detection by mutual
funds that are trying to prevent market timing activity. (Fortune,
November 24, page 92)
Value at Risk
In Mafia Buzz 13 I commented on an article written by Graeme
Tosen on VAR. I said: “I would have thought that one could
halve these percentages as we are only dealing with one half of the
population mean.” He replied the day MB was published – I now
have evidence that at least one person reads this publication! Here
is his reply: “The fact that you only deal with one half of the
population has already been factored in. The standard deviations
used in the example (1,28, 1,65 and 2,33) are for one-tailed tests.
If you performed a two-tailed test you would use 1,53, 1,75 and
2,67.” Thanks Graeme, you are a star.
Gross Domestic Product
GDP is a measure of total economic activity. It measures total
production of goods and services within an economy that are not
then used in producing other goods and services. It can be
expressed in three ways:
1. The sum of value added for all those involved in productive
activity.
2. The sum of all expenditures on goods and services, less
imports.
3. The sum of incomes generated by domestic production.
(Accountancy, December, 2003, page 52)
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Mafia Buzz 2003
Fun Corner
Donald Rumsfeld won the foot in mouth award for the following
utterance: “Reports that say that something hasn’t happened are
always interesting to me because, as we know, there are things we
know we know. We also know there are known unknowns, that is
to say we know there are some things we do not know. But there
are also unknown unknowns – the ones we don’t know we don’t
know.” (Now you know!)
Second prize went to Arnold
Schwarzenegger who said: “I think gay marriage is something that
should be between a man and a woman.” (Citizen, 2 December
2003)
A young person asked Charlie Munger, vice-chairman of
Berkshire Hathaway (of Warren Buffett fame), how he can
become rich like him but faster. His reply was: “Spend each day
trying to be a little wiser than you were when you woke up.
Discharge your duties faithfully and well. Step by step you will
get ahead, but not necessarily in fast spurts. You build discipline
by preparing for fast spurts. Slug it out one inch at a time, day by
day. At the end of the day, if you live long enough, most people
get what they deserve.” (Charlie, the guy wanted to know
“faster”!) Other advice given was: “You need to read, and read
and read.” And: “The idea of caring that someone is making
money faster than you are is one of the deadly sins. Envy is a
stupid sin because it’s the only one you can’t have fun at.”
Suggested motto for SARS: We have what it takes to take what
you have. (Finance Week, 10 December, page 62)
Honest criticism is hard to take, particularly from a relative, a
friend, an acquaintance or a stranger. (Franklin P Jones)
How does one account for Mr. Claus’s fleet of nine reindeer?
Well these are biological assets but Mr. Claus does not carry on an
agricultural activity so they are dealt with under property, plant
and equipment (cost or value and depreciate). (Accountancy, Dec.
2003, page 86)
Websites to Visit
Here are some websites you could visit:
www.iasknowledge.com for international accounting issues.
www.icaew.co.uk for news items in the UK.
www.ifac.org for auditing standards.
www.saica.co.za for all sorts of professional matters.
www.paab.co.za also for all sorts of professional matters.
www.aimr.org for information on CFA.
www.hotchicks.com for . . . sies!
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