2009

Are accountants to blame for the global crisis?

Published on: 14 Oct 2009

A few accounting standards arguably have an unfortunate tendency to exaggerate the economic cycle.  During a time of economic downturn, the chances of a company having impaired assets is increased.  This has the unfortunate effect of taking poor trading results and augmenting them with impairment losses.  In other words, accounting conventions take a bad situation and make it worse.

Or so some people would say.

Some financial instruments are also shown at fair value.  Fair value is primarily decided by reference to market values. During a slump, this also makes reported results worse.

The argument advanced by many is that we ought to amend accounting standards to introduce some sort of dampening effect – requiring companies to impair assets or make provisions during times of boom and release these provisions during a slump.  This, it is argued, is only the equivalent of making hay while the sun shines.

There’s only one problem with this idea of “dynamic provisioning”. Mostly, it flies in the face of the definition of a liability in the Framework. Also, it’s precisely the opposite of what IAS 37 and IFRS 4 (insurance contracts) aimed to do. Fiddling with the accounts to save people from unjustifiable optimism and excessive, groundless pessimism might be politically popular in the current  market turbulence, but arguably it would only reduce the reliability of financial reporting in the long term.  Investors ought to be smart enough to use other information provided to them, such as the statement of cash flows, before reaching judgement on the desirability of a company’s shares.

We hope that the IASB stick to their guns and resist the pressure to codify creative accounting and massaging figures by bogus provisions. We’re confident that they will.

How could Bernie Madoff make off with so much cash?

Published on: 11 Oct 2009

Bernie Madoff is in prison and he handsomely deserves to be.  Over years, he ran a private investment fund that took deposits from rich investors and delivered consistently great returns of 10% real terms each year or more.

The only problem is that the whole thing was a vast fraud. He was stealing funds and using new depositors’ funds to hide the hole his pilfering was creating.  It’s called a ponzi scheme and is strictly illegal.   Total investor losses are estimated to be in the region of £18 billion.

Can you even imagine such a figure?

The question is – how did he get away with it?  There’s no single answer, but these features are significant:

• There was a very excessive degree of authority and power vested in one man (Bernard Madoff himself).

• There was a lack of scrutiny by directors and senior management and investors themselves.

• A whistleblower had contacted the regulator ten years before the scandal broke saying that the returns made were mathematically impossible. The regulator did nothing.

• The auditor was too close to the client and generally showed a deep lack of professional scepticism.

So, Madoff was a colossal failure of corporate governance.  Almost every significant principle of the Combined Code was broken. Yet this happened in the USA – home to the stringent Sarbanes-Oxley Act. How could this happen? Well, SOx only applies to listed companies and Madoff was a private equity investment, so outside its scope. There appeared to be no appetite for voluntary compliance with best practice.

Perhaps the biggest lesson is that when investors are being given apparently huge returns, they become unwilling to ask questions.  Indeed, investors who asked too many questions were dropped by Madoff as being a nuisance.  Maybe the victims of the Madoff scandal became victims of their own credulousness and greed?

When is a non-executive not a non-executive? Ask Stelios!

Published on: 07 Oct 2009

You may have heard of easyJet. You may have flown with easyJet. You may be Stelios, in which case the public thinks that you own easyJet, but you actually only own a minority interest. The public also thinks that you’re the CEO, but actually you’re not even an executive director.

What you do own, if you happen to be Sir Stelios Haji-Ioannou is approximately 66 million easyJet shares and the easyJet brand, which you licence to easyJet.

Sir Stelios is the public face of a company that he founded and grew to a state of financial health where it could buy its most bitter rival, list on the London Stock Exchange and generally grow up rather quickly.  He resigned as an executive director in 2003, becoming a non-executive.

In 2008/09, he had a major difference of opinion with the executive directors over the strategy of the company.  Having been outvoted, Sir Stelios (a non-executive director, remember) sought to increase his equity ownership of the company again to a level where he could appoint some favoured nominees of his own as executive directors; thus giving him (a non-executive director) effective control once again.

Sir Stelios was naturally acting in the best interests of the company as he saw them. The Tyson report lists four duties of a non-executive director (see our ExPress notes if these don’t trip off your tongue! /expand/14-p1_professional_accountant.html) These include scrutinising executives, but not sacking them if they disagree.

It all makes it easier to see why the UK Combined Code requires that non-executives should be paid a basic salary only and have no shares or share options in the company, as well as requiring you to wait at least five years outside the company if you’d previously been a senior executive there!

Marks vs revenue

Published on: 04 Oct 2009

We know the allocation of marks in the exam between the various taxes but what about the revenue generated?

ACCA F6 students will be well aware that the vast majority of marks available in the exam are in connection with income tax and corporation tax. Other taxes such as CGT and VAT also play an important part but not to the extent that income tax and corporation tax do.

Whilst these two taxes represent the bulk of the marks in the exam, how does it compare with the split of revenue generated by the various taxes?

HMRC have published their statistics for 2008/09 which provide the following information:

Total £439bn 100%
Income tax £148bn 33%
National insurance £97bn 22%
VAT £78bn 18%
Corporation tax £43bn 10%
CGT £8bn 2%

Over 50% of revenue is generated from income tax and national insurance alone. CGT on the other hand only generates 2% of the revenue.

I’m sure however that the key % in students minds at the moment is the 50% they need in the exams next month so good luck with your studies in the next couple of weeks!

Organic, Natural and Ethical or fraudulent trading?

Published on: 30 Sep 2009

‘Organic, Natural and Ethical’ is what the One stood for in the name of a company called Onefood.

Reported recently in the UK media, I think this case could well become my new lecturing example for the criminal offence of fraudulent trading.

Ostensibly the company was supplying the famous London food store Fortnum & Mason (as well as others) with organic produce. In reality, the company was buying cheap non-organic foods in supermarkets such as Waitrose and Tescos, removing the original packaging and then replacing with the company’s own packaging.

Neil Stansfield the CEO of the company, who also traded under the name of Swaddles Organic was quoted in a local newspaper as saying “Fortnum & Mason searched for the finest British classic pie throughout the UK and after arduous searching they came upon Onefood and Swaddle, sampled the product and found it to be the best in the UK. We’re impassioned by supplying natural, ethical and unadulterated food and we’re here to educate consumers about the well-being that comes from choosing British-grown organic meat.”

In truth the pork pies being referred to were bought from a local butcher for £1.30 and sold to Fortnum & Mason for £2.50. In another example given in court, a salmon purchased from Waitrose for £20 was sold on for £51.

Stansfield, his wife Kate (who acted as Company Secretary) and Russell Hudson (the company operations manager) all pleaded guilty to fraudulent trading. Neil Stansfield was sent to prison for 27 months and disqualified from working as a company director for 6 years. Kate Stansfield was sent to prison for 50 weeks, ordered to do 150 hours community service and banned from being a company director for 3 years. Russell Hudson received a 40 week prison sentence, suspended for 2 years and was ordered to do 150 hours community service.

Now where’s that organic chicken I was going to roast for supper tonight?

Do you know your cost of capital?

Published on: 26 Sep 2009

The other day I was talking to a few local business owners and I asked them if they knew what their cost of capital was. I got a few blank stares.

When we discussed the issue further, people started to warm up to the idea that the cost of capital can be viewed in terms of opportunity costs:

1. One owner said his cost of capital was the interest rate on his bank loans. I suppose he was 100% debt financed and probably not planning to refinance any time soon! Good luck to him!

2. A second owner said he took out all his savings from the bank and put it into his business. Since the bank deposit rate was so low, he figured his opportunity cost was pretty low as well. He has a point, though he must realize that he has moved into a higher risk category by withdrawing his money from the bank and investing it in a start-up business.

3. Another business owner said he started his company by borrowing from his relatives. Since they haven’t asked for it back he assumes its cost is zero. But he does pay a price, I suppose: at family gatherings he gets dirty looks from his relatives and his wife gives him constant grief. He suspects that the relatives complain about him to his wife.

Since all three owners want to expand their businesses, they asked me if I could recommend new sources of finance. I thought of sending them to our P4 candidates (after the exam!).

The Premier League and the UK income tax rate…

Published on: 23 Sep 2009

Cristiano Ronaldo’s well publicized move from Manchester United to Real Madrid in the summer understandably received a lot of publicity. A world record football transfer fee of £80m is bound to catch the attention.

Ronaldo’s first year remuneration from Real Madrid is reported to be in the region of £11m. Students sitting the 2009 exams should be well aware that the 40% tax rate for the 2008/09 tax years applies to taxable income above £34,800. An individual in the UK with annual earnings of £11m would exceed the 40% threshold in just 2 days!

There were no doubt many factors that persuaded Ronaldo to move to Spain to play for Real Madrid. From a tax point of view though, Spain has favorable tax legislation that enables foreign players to pay tax in the region of 23%. When you compare this figure with the 40% top rate in the UK (and the upcoming 50% tax rate which is not examinable in the December exams) and apply the difference to the amounts of remuneration that Ronaldo is earning then the tax bill  would be significantly lower in Spain than in the UK. Approximate figures show a difference in tax next year when the 50% rate is in place of nearly £3m per year. This adds up to a significant amount when looked at over his contract period of 6 years.

Of course the football purists amongst us would argue that it’s the football team and supporters that are important rather than the tax bill but then again I can’t be sure about this until somebody offers me £11m a year to live in the sun in Spain!

Nice car, shame about the usage…

Published on: 19 Sep 2009

As promised, the blog will be used to build up your database of decided cases for ACCA F4 purposes and increase your CLOUT in the F4 exam room.

Case 190 1997

The defendant, an Austrian seller of imported Italian cars, sold a Lamborghini Countach to the plaintiff, a Swiss buyer. The seller, however, was not able to make delivery of the car to the buyer.

The court held that as the car was purchased for personal use (if I had one I wouldn’t let anybody else drive it!), in accordance with Article 2(a), the CISG did not apply to the case.

However, the court indicated that the CISG could have been applied to the case if the fact that the seller ‘neither knew nor ought to have known that the goods were bought for any such use’ had been proved by the buyer.

The largest single property deal in UK history, both in form and…in substance

Published on: 16 Sep 2009

Sale and leaseback of a very noticeable building by a very noticeable bank! Is this a sign of a bank needing cash flow to shore up its solvency? Or just a good opportunity at a good moment in time? And how do we tell the shareholders about it?

In 2007, HSBC sold and leased back its iconic headquarters in London, the 1.1 million square foot, 210 metre high, tower at 8 Canada Square, Canary Wharf.

Imagine yourself in a top floor office as a proud HSBC accountant about to book this transaction in the bank’s IFRS statements.

The buyer-lessor was a wholly-owned subsidiary of Metrovacesa, S.A. one of Europe’s highest profile property companies. Under the terms of the agreement, HSBC sold the tower for £1.09  billion and leased it back for 20 years (with an extension option for a further 5 years) against an annual rent of £43.5 million. HSBC had moved in 2002, having incurred some £500 million in tower’s construction costs.

So, how would you account for it?

First, you need to determine the nature of the lease: finance or operating? Based on available information, the lease has fair chances to be operating, as (a) the term is 20(+5) years, with the building (the useful life of which may exceed 40 years) being only 5 years old on lease inception, and (b) the present value of the agreed annual rents probably falls significantly below the upfront selling value.

If that would be the case (operating lease-back), you would (a) take the building out of HSBC’ balance-sheet at its carrying amount, (b) recognise upfront the profit made on disposal, and (c) subsequently take the incurred rental costs to operating expenses, on an accruals basis.

Fairly straightforward, isn’t it ?

Cider and spreadsheets

Published on: 12 Sep 2009

Cider drinks and spreadsheets – what’s the link?

Cider is an alcoholic drink made out of apples and has become more popular in recent years in the UK. One of the most popular brands of cider in the UK is Magners cider, the brand owned by the C&C Group.

We all know that there are lots of benefits of using spreadsheets such as Excel (e.g. speed of use, quantity of data that can be analyzed, etc) but we should all be aware that mistakes do happen with spreadsheet.

Earlier this summer shares in the C&C Group fell approximately 15% after the group said that revenue in the 4 months to the end of June had fallen by 5% rather than the 3% increase that had been reported a week earlier!

The group’s Finance Director said that the error in the earlier announcement occurred after data was incorrectly transferred from an accounting system to a spreadsheet used to produce the trading statement. Quite an embarrassing mistake and a valuable lesson in that even if spreadsheets are extremely powerful tools in business if the wrong data is inputted you will receive misleading results.

Also, it should be stated that consuming excessive amounts of cider when using excel could result in unpredictable results…

The ExP Group