August 2010

“There’s no such thing as a free lunch” but will there be such a thing as a free drink or cheap drink in the future?

Published on: 30 Aug 2010

Binge drinking in the UK is a major problem. City centres at the weekend can be full of people that are literally trying to drink as much as possible in as short a period of time. Violence and health issues often ensue.

As well as the disturbances to local residents there are also the costs both health-wise to the drinkers and financially to police forces, hospitals and society at large arising as a result of this binge drinking.

As a potential solution to this problem, the government is currently investigating whether to ban free or cheap drink promotions. One of the ideas being discussed is whether to make it illegal to sell alcohol below cost price. In other words to prevent businesses offering “loss leaders” on drinks so as to encourage higher spending at a later date.

If you’re an accountant, and assuming you’re not reading this in the middle of an actual binge drinking session yourself, this raises an interesting discussion on what exactly is meant by “below cost” and in particular the term “cost”.

The major alcoholic drinks manufacturers produce a range of drinks. Diageo for example produce drinks as varied as Smirnoff vodka, Johnnie Walker whisky and the famous Irish stout Guinness.

Identifying the cost of each particular drink would be challenging exercise. Whilst they no doubt have sophisticated management accounts which allocate overheads and indirect costs in certain ways, there would be a clear debate as to which was the “correct” allocation of these costs.

Apportioning overheads such as head office costs, R&D and marketing to individual products would result in a certain amount of flexibility in terms of identifying the cost figure to use for “below cost” purposes.

One solution to this inherent problem of identifying the cost of individual products has been proposed and that is setting the minimum cost of the drinks as equivalent to the duty and VAT that needs to be paid on the particular drinks.

So, the next time you’re out having a quiet drink with some non finance friends feel free to start a discussion about how much each of your drinks cost to make. You can then explain about the various possible methods of allocating indirect costs. Then again, talking about management accounting cost allocation whilst out with your friends may result in your  non finance friends starting a binge drinking session themselves…

I take my hat off to Bethany Hare, Charlie Chaplin and Mendelow’s Matrix but should I be smiling?

Published on: 27 Aug 2010

Bethany Hare is a remarkable young lady. She’s only 10 years old and wanted to raise money for a local children’s hospice.

She came up with the idea of dressing up as Charlie Chaplin, singing the song “Smile” (the theme from Chaplin’s 1936 film “Modern Times”) and then posting it on a charity website.

She was aiming to raise £5,500 and it all started well with people appreciating the effort she had put in and making donations.

She was then contacted by New York based Bourne Music Publishers, who own the rights to the song. Several discussions between Bethany’s mum and the Publishers later and the end result was that Bethany was told that she must either remove the song or pay a license fee of $2,000 to keep it online for one year plus a further $250 every time she performs it in public.

This is a lot of money for a little girl of 10 years old to pay to a big music publisher especially when she’s trying to raise £5,500 for terminally ill children. Bethany removed the song from her video and in true Chaplin style ran it as a “silent movie”.

A lot of people will question the approach taken by Bourne Music.

Mendelow’s Matrix is a method of analysing stakeholders in a business. According to this model the stakeholders that management should really look after are the “key players” (high interest / high power). Bethany falls within the low interest / low power quadrant of Bourne Music’s matrix and hence the theory goes that they can employ “minimal effort” to this category.

Some would argue that they had a duty to protect the song and obtain all the royalties they could from it but it seemed obvious that Bethany was never going to pay that sort of money.

This story has however got a happy ending. Ben Model from Silent Clowns in New York wrote a piano score especially for Bethany to use and she has now reached her money raising target. Bethany’s performance can be seen here.

I’ll leave it up to you to decide who you think are the good guys and the bad guys in this story. My view is that the title of the song in debate was “Smile” and I’m pretty certain that not a lot of people were smiling when they heard the approach taken by the Publishers.

The ACCA exam results are out today. If you’ve been successful then maybe head to the vending machine.

Published on: 23 Aug 2010

It’s ACCA exam results day today and congratulations to those of you that have passed. All your hard work has paid off and it’s now time to celebrate.

I’ve often wondered whether the results day should be a Friday so you can celebrate on Friday night and Saturday night or whether it’s a good excuse to annoy everyone else in the office on the Monday with your shouts of happiness all day.

If by any chance you’re in Pennsylvania in America and want to have a little drink to celebrate your success then there is now a novel way of doing so.

We blogged last year about the use of vending machines in Germany for selling local fruit and vegetables but in Pennsylvania they are now piloting a new type of “outbound logistics” (using Porter’s Value Chain Analysis terminology).

You can now buy bottles of wine from vending machines. In order to buy the wine customers have to firstly prove they are old enough by swiping their ID and a credit card. They then have to prove they are sober enough to buy the wine by using a breathalyzer.

Wine aficionados may well be aghast at the thought of buying wine from a vending machine but if you’re the type of person that just doesn’t want to stand in a queue and talk to the shop assistant when you’re buying the wine then this could be for you.

Then again, if you’re buying it to celebrate passing your exams I would recommend that you buy it from the shop assistant so that you can tell them and the rest of the people in the queue the reason you’re buying it.

Things are getting more expensive in China but is this good news for McDonalds?

Published on: 20 Aug 2010

A report issued by Credit Suisse this week highlighted the fact that costs of manufacturing in China are on the increase.

Average salaries for example have increased from $1,000 per annum in 2000 to nearly $4,000 in 2010. This increase, together with the cost of transporting goods to Europe and America, means that the cost base has increased significantly and importantly is likely to continue to increase.

A number of companies have invested in China principally on the basis of their low cost base.  The rising cost base though is causing concern for a number of companies.

Will they be able to switch production to other low cost locations such as Bangladesh or Vietnam? They probably will be able to but it could be costly.

Will they be able to pass on these cost increases to the end consumer by way of price increases? Given that we are only just starting to come out of recession my guess is that this will be challenging to say the least.

But does all of this really come as a surprise? With the explosion of globalisation over the last couple of decades and companies manufacturing in cheaper location or “off shoring” services then surely it’s simply a case of supply and demand.

If companies set up offshore operations in a certain territory which is renowned for having, for example, good quality cheap IT skills then when other companies join them there will be a surge in demand for these individuals and wages will increase.

It will take a number of years or even generations but some people’s view is that eventually there will be very similar wage levels wherever you are in the world.

Back to the increase in wages in China though and whilst this will be bad news for a number of companies there will also be companies that will benefit from the increase in local spending power. McDonalds for example are no doubt licking their lips in anticipation at all the Big Macs that could well be sold in China in the near future.

A previous Ernst & Young award winner (allegedly) held meetings in his underwear, Deloitte resigned and there’s no sign of the cash anywhere…

Published on: 18 Aug 2010

Two weeks ago we blogged about Deloitte’s decision to resign as auditors of American Apparel due to amongst other things, problems with stock valuation.

Yesterday, the investor relations department of American Apparel released a press release which included the disclosure that “the Company believes that it is probable that as of September 30, 2010, the Company will not be in compliance with the minimum Consolidated EBITDA covenant under the second lien credit agreement”.

In simple terms this means that it may default on some of its loan payments. This is obviously bad news for all stakeholders of the business as the company may simply not have enough cash to stay in business. Their share price fell by 22% in late trading yesterday.

This is quite a fall from grace for the company and its charismatic founder and CEO, Dov Charney. Back in 2004 at the height of the company’s success Mr Charney won the Ernst & Young Entrepreneur of the year award.

Mr Charney is one of the real characters of the fashion industry in America and in the past has faced sexual harassment claims as well as allegedly attended interviews and company meetings in his underwear (no doubt American Apparel underwear).

The situation today though is that the company is in negotiations with its creditors to amend the loan agreement to ensure they can stay in business.

It’s looking like the decision by Deloitte to resign was indeed a sound decision. The new auditors, Marcum, will no doubt have some challenges ahead but one thing’s for sure and that is they should issue their invoice to American Apparel now and start chasing up payment straight away.

If you’re going to buy shares in Skype then watch out as the Sky could be the limit.

Published on: 13 Aug 2010

The internet telephone company Skype is planning on raising $100 million via an IPO (Initial Public Offering) on New York’s NASDAQ later this year.

Skype is probably the best known “internet telephone company” and users can make free Skype-to-Skype calls. Paid for calls to mobiles or landlines can also be made.

$100 million however is a significant figure and the filing documents submitted on Monday show that in 4 of the last 5 years the company lost money. In addition, the proportion of Skype’s customers that use the paid for services is also relatively small (8 million out of total registered Skype accounts of 560 million) so arguably there’s a real risk that it may be a significant time before the company is well into profit making territory.

The IPO submission documents must also show any identified risks and there is an interesting one present with Skype.

If you look at page 30 of the IPO submission document it was revealed that BSkyB, the owner of Sky TV in the UK, is in a long running dispute with Skype over the use of various trademarks. There is a view that Sky and Skype could be confusing for certain individuals especially given that BSkyB are promoting their telephone services alongside their Sky TV services.

It’s a case of watch this space to see what happens next.

Of course, free phone calls are one thing but if Skype ever started showing free television programmes then that’s when things would get really exciting.

Forget the sunshine, the beaches and the fantastic food – if you live in Australia sell your house and move to America…

Published on: 11 Aug 2010

Asset valuation is a tricky business.  It is, however, a skill that accountants are often commissioned to use.  It’s also a useful one to have when making personal decisions, such as whether to buy a home or not.

Some people would argue that a major driver of the current economic slump in many countries is the collapse of house prices.

In a number of countries, house price bubbles were enormous.  There are lots of motivations for buying a home; principally as a place to live, a store of value for the future; certainty come retirement (when the mortgage is paid off so housing costs drop only to be maintenance).

Another motive has been speculation.  In my opinion, speculation in house prices is a bad thing, since it drives up house prices.  This means that new houses are not affordable for the young.  The more that house prices go up, the greater the transfer of wealth from the economically active young to the less economically active old.

Unsustainably high house prices cause uncertainty in an economy and when a crash eventually happens, it can cause people to be locked into homes with loans greater than the value of the asset (negative equity).  As well as a source of human misery, negative equity reduces labour mobility, which is bad for the economy as whole.

The Economist newspaper tracks house prices in different countries, using a method based on rental yields.  The assumption here is that rental markets react more readily to underlying supply and demand conditions.  If one had $500,000 to invest, would one use it to buy a house which could then be rented out, or buy other investments such as bonds?  If the rental yield (rent / initial value x 100) is less than the yield on bonds, then the house price is overvalued.  It’s a simple enough methodology that can give some revealing results.

A couple of years ago, this analysis suggested that UK property prices were 35% overvalued.  A crash followed.  There have been property crashes and recession in many countries where speculation is a big motive to buy property.  The alarming thing is that a recent analysis (Economist 10 July, page 75) revealed that properties are under and overvalued in certain countries:

UK: 33.8% overvalued (following a hard-to-explain recovery in house prices)
USA: 6.5% undervalued
Spain: 50.4% overvalued
Australia: 61.1% overvalued
Germany: 14.5% undervalued
Ireland: 15.7% overvalued.

This may be poor news indeed for the economy of countries with very overvalued property.  With these sorts of valuations, mortgages may become unaffordable the moment that interest rates rise to above the rock bottom levels we have at the moment.  This could release very big downward forces in the economy and dampen out any economic recovery.

On the plus side, the USA looks to have reacted quickly, albeit brutally, to the changed economic circumstances and it might be a good time to sell your home in Australia (cash out your investment while it’s arguably overvalued) and buy somewhere in America.  If you can get a visa.  Oh, and a mortgage!

If it’s “Dress Down Friday” today at Deloitte would you look good in American Apparel clothes?

Published on: 06 Aug 2010

It was announced recently that Deloitte has resigned as auditor of American Apparel.

American Apparel is the largest clothing manufacturer in the United States.  The company has expanded substantially outside the USA in recent years, meaning that a material proportion of their sales and inventory happen in territories where US GAAP is not the local requirement.

This appears to have created some problems.  The company was previously audited by Marcum LLP, but it changed auditor to Deloitte on 3 April 2009.  Deloitte had reported an audit opinion and opinion on corporate governance compliance.  These gave an opinion that the company did not have staff outside the USA who were adequately trained in inventory valuation (presumably in inventory valuation in accordance with US GAAP rather than IFRS) and that controls over inventory outside the USA were below the standard that Deloitte considered to be fit for purpose.

Marcum, the previous auditors, had expressed an adverse opinion on the corporate governance report in the financial statements for 2008.  Some saw this as a critical event in the replacement of auditor with Deloitte.

Resigning as auditor is a drastic step that is likely to have an adverse impact on the company’s share price.  American Apparel’s share price nose dived by 25% when the stock market heard of the news of Deloitte’s decision to resign.  Presumably this is because investors have new doubts about the reliability of the company’s historical financial information and future prospects.

As for the name of the proposed replacement for Deloitte?  Apparently, the company’s favoured option is a firm called Marcum LLP…

It’s all very well buying a shop for £1,500,000,000 but there’s just nowhere to park your car when you arrive for work.

Published on: 04 Aug 2010

Harrods, arguably the most famous shop in the world, was recently purchased by the Qatar Holding Group from Mohamed al Fayad. The price paid was £1.5billion which is a pretty large amount of money in anyone’s books.

The Qatari ruling family are behind the Qatar Holding Group and have interests in a number of businesses around the world. They also have a fleet of super cars including a Lamborghini Murcielago worth £350,000 and a Koenigsegg CCXR worth slightly more at £1.2 million.

No doubt there was a comprehensive due diligence exercise undertaken before the purchase of Harrods with accountants and financial advisers going through the business and the accounts in fine detail but did anyone ask where the parking spaces were? Harrods is in Knightsbridge in central London and is renowned for being short of parking spaces.

The Lamborghini is capable of going from 0 to 60 mph in 3.2 seconds whilst the extra £850,000 it costs to buy the Koenigsegg enables you to get to 60mph 0.3 seconds quicker at 2.9 seconds. Recently however, they went from 0 to 60 mph in approximately 3 hours.

The cars were illegally parked outside Harrods and after initially being given parking tickets were then clamped and a passerby filmed the results.

The parking fines were £120 for each car but by paying them within 14 days they were reduced to £70 each.

Vodafone and their involvement with CFC (no, not Chelsea Football Club)

Published on: 02 Aug 2010

There’s a pretty good chance that either you or somebody you know has used a Vodafone network.

Vodafone are the world’s largest mobile telecommunication network company and last week they announced better than expected results for the quarter ended 30 June 2010 with revenue rising for the first time since the recession began (rising by 4.8% to £11.3 billion for the 3 months).

Also announced was an agreement with the UK tax authorities over a Controlled Foreign Company (CFC) investigation that dates back to 2001.

In simple terms, CFC is a set of rules which prevent UK companies from avoiding tax by the use of subsidiaries in tax havens around the world. If for example a company pushes profits into a subsidiary in a low tax jurisdiction it would avoid paying the higher rate of tax on these profits in the UK. The UK tax authorities can counter this by applying CFC legislation.

The Vodafone case was a complicated one involving a holding company in Luxembourg. It had made a provision of £2.2 billion for settlement of the dispute but has now agreed to pay £1.25 billion to settle all outstanding CFC liabilities to date as well as reach agreement that no further CFC obligations will occur under current legislation.

This is not only good news for Vodafone but also a number of other multinationals that are currently in negotiations with the tax authorities over CFC issues. It also reportedly signals a more flexible approach by the tax authorities as the new UK government has stated that they wish to make the UK open to international business. Over recent years a number of companies have moved operations away from the UK to for example, Ireland where there is currently no CFC legislation in place.

The ExP Group