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

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

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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.

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.

How can you make a salary of £26,000 stretch to buying a horse riding business, a holiday home, luxury holidays and a Range Rover costing £45,000?

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It seems that not all accountants are 100% honest.

Whilst the vast majority of accountants are  trustworthy there were two court cases in the UK this week that resulted in jail sentences for accountants.

Gary Gordon, who previously worked for the Big 4 firm PricewaterhouseCoopers, stole £45,000 from his employer UK Mission Enterprises. He rather unimaginatively simple diverted the cash into his own accounts.

He apparently had a gambling habit and didn’t appreciate the amount of money that he had stolen. He’s been jailed for 16 months.

£45,000 however pales into insignificance when compared with £1.3 million which was the amount that Tracey Laws stole from her employer Inchcape Limited.

Inchcape Limited is the parent company of a number of motor trading companies in the UK and for nearly 10 years Laws wrote 75 fraudulent cheques totaling £750,000 to her own horse riding school (which she had set up with money that she had already been stolen from her employers). She had also fraudulently transferred over £500,000 to her husband’s decorating company.

Despite having a maximum annual salary of £26,000 during her time with Inchcape she managed to buy a horse riding school, a holiday home, luxury holidays and a brand new Range Rover.

It wasn’t these mis-matched spending habits that caught her out though. Her crime was uncovered by accident when one of the motor trading companies was changing payment systems and two employees noticed a cheque made out to West Acres Stables (the stables owned by Laws).

These two observant individuals noticed that the handwriting looked very much like the handwriting of Tracey Laws. It turned out that it was her hand writing and the end result was that Laws was jailed for four years last week.

No doubt there are new internal controls in place at Inchcape and looking on the bright side for Laws she will at least save her annual accountancy membership fees going forward and she will also have her bed and breakfast supplied free of charge by Her Majesty’s Government for the next few years.

What will make Ernst & Young different from the rest of the Big 4? Will it be an Executive Decision or…

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According to reports this week, Ernst & Young will be the first of the Big 4 to appoint non-executive directors to its global advisory council.

This is a major move for the accountancy profession.

The profession has been under increasing regulatory pressure for a while now and the decision to appoint non-execs is reportedly in response to the new audit firm governance code that was published earlier this year.

The revised Ernst & Young advisory council structure will in broad terms mean that Ernst & Young will have a board structure which is similar to the multi-national companies that are their clients. Their remit will include monitoring strategy and risk.

Their global advisory council currently includes 36 senior partners. These partners will soon be joined by 4 non-executive directors drawn from the business and regulatory world.

The names of these non-execs will be disclosed later this year and although I’m not a betting man I’d probably have a wager that their CVs will not include the names of Deloitte, KPMG or PricewaterhouseCoopers.

Fabio Capello’s comedy version of Sydney Pollack’s classic film “Out of Africa” was complete and utter…

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So then, England’s football team are back home following their worst defeat in a World Cup ever.  As an Englishman, I care about this very much, but I’m trying to be brave about it.

Germany deserved to win.  They played better and importantly played as a team. England were fragmented and dreadful.

But the official score of 4-1 was rubbish.  The second goal went over the line by about a whole metre. Unfortunately, FIFA “disallowed” the goal because the linesman didn’t see it and they refuse to install goal line technology.  The official reason for this is that many countries can’t afford that technology, which is doubtless a fair argument.  But surely countries that can’t afford expensive “Hawkeye” style equipment that the major tennis championships use could still afford to pay a responsible person to stand by each goal line through the match and call when a ball goes over the line?  This feels like very poor judgement.

In the UK at the moment, we’re questioning three things in connection with the World Cup.

1.    How can England have been so bad? There are no immediate answers to that.

2.    How can FIFA possibly believe that their reputation can be held intact when they refuse to listen to the reasonable arguments of so many stakeholders?

3.    How is it that the England manager (Fabio Capello) can be entitled to a £12 million severance package if he’s fired next month?  His team’s performance was a dismal failure, so surely he should go.  £12 million is what’s technically known as “an awful lot of money to pay a loser”.

It feels to me that the Football Association in the UK could benefit from a reading of the ACCA paper P1 notes.  Executive remuneration being linked to performance and ease of firing a non-performing executive (Fabio Capello) and how to protect reputation (FIFA).

We’ll give them a course free if they want it.  They both need it.

IFRS 911: Accounting for environmental catastrophes? The BP oil spill illustrates a number of issues in IFRS. Here are just the first few we thought of..

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BP chief executive Tony Hayward was grilled yesterday by the US Congressional panel.

The failure of the Deepwater Horizon drilling platform has been a catastrophe for lots of people. Stakeholders ranging from individual fishermen through to major shareholders have all been severely impacted.

Being natural accountants though, we couldn’t help but think how this would affect the accounts, given that it may well inspire some future exam questions.

The most obvious effect is the impairment of the well itself.  Only the hardware is currently recognised in assets, since the value of the reserves is too uncertain to be recognised as an asset.  Rigs cost vast amounts of money however and this is a significant impairment.

Similar drilling arrangements will also require major safety upgrades.  This would cause an impairment, but no provision, since BP could always simply close down a well.

Then there is goodwill.  BP grew to its vast size by organic growth and by acquisition.  This activity may well have been through an acquired subsidiary.  This is pretty solid external evidence of an impairment and so goodwill must be written off.  Lots of goodwill needs to be written off.

Fines are a near certainty.  The White House has been careful to ensure that the world knows that the $20 billion payment to a trust to settle damages is not a full and final settlement.  This means that an estimate of likely costs will need to be made and disclosed in a very transparent way.  BP and BP’s lawyers would probably prefer to avoid that transparency of how much they think this is going to cost them.

A number of years ago, IAS 10 was amended to require that only dividends that were legally required to be paid could be shown as liabilities.  Many people commented on how this was not true and fair, since it was unthinkable that large companies could ever change their minds about dividends that had already been proposed.  Well, BP changes that a little, given that they have agreed to skip this year’s dividend to shareholders, in response to huge pressure from wider stakeholders such as affected communities and the President of the United States.  It turns out that companies do sometimes change their minds about dividends before the cheques get sent out!

What about recoverability of insurance proceeds?  That one is simple; BP did not have insurance we believe.  Ouch.  Dare we breathe the words “going concern”?

Singing, dancing, puppets and Enron. Of course it makes sense…

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I had a great weekend and on Saturday was lucky enough to see the play Enron at the Noel Coward theatre.

Enron is arguably the best known corporate bankruptcy in recent years. The US energy and communications giant collapsed in 2001 owing approximately $60 billion. The collapse of Enron is well documented.  Jeffery Skilling, the CEO of Enron, was keen on mark-to-mark accounting systems which allowed notional value to be given to ideas which might pay off in the future. Billion dollar losses were disguised as profits. Skilling was sentenced to 24 years in jail for fraud and Kenneth Lay, Enron’s founder, died before sentencing.

Enron was also a major factor behind the introduction of the Sarbanes-Oxley Act and also the collapse if its auditor Arthur Anderson resulting in the “Big 5” becoming the “Big 4”.

Whilst on the face of it a play about accounting fraud at a US corporation doesn’t sound the most exciting thing to watch it really was very well put together. Theatre, dancing, singing and puppets all added to the drama!

The play was great and if you do get an opportunity to see it I’d strongly recommend that you do so.

My husband is in the medical profession and he is always joking that accounting and finance is easy. Unfortunately the play was so good at explaining complex financial issues in a relatively straightforward way that he is now even more convinced that finance concepts are easy to understand!

RBS directors threaten to resign

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In terms of examples of risk management and corporate governance, UK based banking group Royal Bank of Scotland (RBS) just gives and gives.  It’s an unfolding story that continues to grow.

RBS was a big success story in the last decade, showing very fast growth and taking over bigger banks such as Nat West.  Its considerable returns appear to have been won, rather predictably, by taking a high level of risk.  Previous blog entries have mused on the wisdom of having fired their risk manager.

The banking group was saved from collapse by receiving vast emergency support from the UK government.  This was controversial but almost everybody agrees that it was necessary in order to avoid a collapse of the entire banking system.  Such a collapse would certainly have made the recession very much worse.

The British public thus became an involuntary shareholder in RBS.  Indeed, the UK government now holds a controlling interest in RBS, though it’s been keen to avoid interfering much in the management of the bank.

The image of bankers in the UK at the moment is very tarnished. Most people who have an opinion on senior bank staff have an unfavourable opinion; often seeing them as people who were over-rewarded for taking excessive risks.  Many resent having to bail out a bank ruined by unwise risk management.

So it came as a surprise to many when the directors of RBS said that they intended giving bonuses and pay increases to many staff last week.  This provoked anger from the government and outrage from the public. The RBS board stated that they would resign if they weren’t allowed to pay the bonuses, as failing to pay people well would result in loss of talented staff.

It has to be questioned whether the board have ever studied stakeholder management and the Mendelow matrix. With 70% of the ordinary shares, the government is a key player; the views of the public must be respected.  If that means the synchronised departure of the board of RBS, so be it.  Bankers’ salaries and bonuses have been in an inflationary spiral in recent years and some bank must be the first to bring their salaries into the realm of sustainable expenses.

It will be interesting to see if the directors follow through on their threat, back down or are even removed from office by the shareholders (ie the government).  Whatever the outcome, their credibility is arguably much tarnished.

Royal Bank of Scotland. Where were the non-executives?

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Royal Bank of Scotland (the UK based banking group) has had its fair share of troubles of late.  It made some acquisitions that in retrospect were a clear mistake, such as its purchase of ABN Amro.  It failed to manage risk properly, having chosen to fire its risk manager; allegedly for making too much noise about the company taking too many risks.  The result of this all was a taxpayer bail out and the enforced departure of its chief executive, Sir Fred Goodwin.

At the time it became obvious that stakeholders were going to require a good degree of blood letting at board level, the bank’s chairman discussed the situation with Sir Fred.  As a result, Sir Fred chose to resign, taking his right to an annual pension of £703,000 with him.  Had he been fired, his pension rights would have been closer to zero.

Much public comment and anger followed, with virtually all of this aimed at the outgoing CEO.  But where were the non-executives?  The general duties of non-executive director are:

Remuneration: decide appropriate pay (including pensions) for executive directors in the circumstances.

Internal control and risk management supervision.  History shows that this is at least questionable.

Scrutinise the executive directors.

Strategy: contribute to strategy.

Sir Fred Goodwin was entitled to his pension.  He later voluntarily chose to waive £200,000 per year, but universal legal opinion is that he would have been entitled to the full amount, because the non-executives allowed him to resign.

Perhaps the press and the public are venting their frustration and anger too much at the executive directors?