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Surely you’re not watching that on your phone?

A few years ago Blackberry used to be the phone of choice amongst business people but the emergence of Apple’s iPhone and various Android smartphones has resulted in sales of Blackberry phones plummeting.

phones-for-accountantsEarlier this year Blackberry launched their new phone, the Z10 and this was seen to be a make or break situation for the company behind Blackberry. Before the launch of the Z10 their latest set of sales results showed a fall of 47% from a year earlier and the Z10 was hoped to stop the fall in sales.

By all accounts it’s a pretty good phone and some commentators are saying that it could even be a rival for the ubiquitous iPhone.

It seems to be doing well but yesterday news emerged of a potential flaw in the design that could lead to some embarrassing situations.

It’s a sophisticated phone and one option it has is to share details of what music you’re listening to with your contacts on your phone. This alone makes you realise how far Blackberry has moved from a pure business phone where its main use was phone calls and emails.

Now, music sharing isn’t the embarrassing bit. Not even if your music listening habits include Justin Bieber.

No, the embarrassing bit is that when the music sharing option on the new Blackberry is turned on it not only shares what music you’ve been listening to but also shares what videos you’ve been watching on your phone.

There have been reports of people being surprised at what videos their contacts have been watching on their phones with some of those videos being how can I say it but, um, adult only videos with content of an adult nature.

A lot of you reading this are qualified accountants or are studying finance so I’m sure that most videos you watch on your phone are about the latest International Financial Reporting Standards so you’ve got nothing to worry about.

Then again there are some people who would maybe argue that it’s more embarrassing to be caught watching Financial Reporting videos than watching videos of people getting friendly with each other.

The 18 page remuneration policy and the £6,500,000 bonus…

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IFRS 2 Share Based Payments has never been a popular accounting standard with many in the business community.

It’s also often unpopular with students, especially the deferred tax elements of it.  This is despite the fact that share based payments often provide an opportunity for easy marks (we promise!)

The reason given for finance directors’ dislike of IFRS 2 is often that it involves subjective estimation of the value of share options and other equity-based compensation.  This can be complicated and subjective.

Another reason why it’s unpopular might be that it involves stating the full truth of how much executives are actually being paid, including non-cash related rewards.

One person who is feeling the heat of this at the moment is Bob Diamond, who is CEO of Barclays Bank.  The bank has just published its remuneration report and it’s predictably controversial.

In an environment where many people, fairly or unfairly, blame perceived greed of bankers for the global financial crisis, CEO remuneration of a salary of £250,000 and a cash performance bonus of £550,000 might be considered brave by many.

But this is only a part of the story.

Once the expected value of equity based remuneration is included, the total figure rises to a bonus of £6,500,000.  In the days before IFRS 2, the total reported remuneration would have been less than £1 million.  No wonder some directors look on the pre-IFRS 2 days as the good old days!

If a person had invested £100 in Barclays shares on 31.12.05, those shares would now be worth £53.  This compares with a profit of 26% on FTSE shares in general over the same period.   At a time when shareholders have taken these substantial losses, this type of remuneration is likely to upset investors.  This possibly explains why the bank takes up 18 full pages to explain (or perhaps justify) its remuneration policy!

Is it a historical drama? Is it a romantic novel? No, it’s a never ending story of…

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Classic Russian novels are famous for being somewhat large.

My copy of Tolstoy’s “War and Peace” weighs in at 1,024 pages.  That is a big book.

Some day, I will get beyond page 20.

Dostoyevski’s “Crime and Punishment” is 448 pages.  I’m up to page 25 on that one.

According to a recent survey by Deloitte of UK listed companies, the size of IFRS accounts grew from an average size of 44 pages in 1996 to 101 pages in 2010.  That’s an annual growth rate of 6%, with a 7% rate of growth in the years from 2005.  The rate of growth itself appears to be growing.

So, just for fun, if you’re of a mathematical bent, and assuming that the rate of growth in volume in IFRS accounts continues at its current pace, answer this question:

How many years will it be before the page count in a set of IFRS accounts exceeds the page count for “War and Peace” and for “Crime and Punishment”?  The answer is at the bottom of this item.

Within all this bulk (which Deloitte criticises as being “swimming in words”), there is some notably useful information, such as 90% of companies clearly identified an average of 7 key performance indicators, up from 84% in 2009.

4% of companies (2009: 7%) received a modified audit opinion relating to going concern.

Surprisingly, only 35% of companies fully complied with the UK’s Combined Code on corporate governance.  That leaves a fair bit of explaining to do, on the “comply or explain” approach.

If you’re interested in the answer to the question of how many years will it be before the page count in a set of IFRS accounts exceeds the page count for “War and Peace” and for “Crime and Punishment” then IFRS accounts, at their current rate of paper busting growth, will be longer than “War and Peace” in 35 years and “Crime and Punishment” in a mere 22 years.

Forget who’s in charge of the TV remote control, who’s in control of the TV channels?

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BSkyB is the largest broadcaster in the UK, reporting a profit of £11.7 million on revenues of £5.9 billion in its most recent financial statements.

Its ownership structure is dominated by News Corporation, the transnational media conglomerate owned by Rupert Murdoch, whose other ventures include numerous newspapers and Fox studios in the USA.

It’s fair to say that Rupert Murdoch is a controversial figure.

A review of the most recent financial statements shows that News Corporation presently owns approximately 39.1% of the shares of BSkyB.  The next two largest shareholders own 5.02% and 3.01% of the votes in the company.

In other words, resisting the might of News Corporation to impose its will on BSkyB would require something more akin to a peasants’ revolt than a more standard company vote in the AGM.

IFRS 3 defines a subsidiary as an entity that is controlled by another entity.

Looking at the evidence, it would appear that the 39.1% ownership would be enough to give control of BSkyB to News Corporation, on grounds that it would be almost impossible to resist decisions favoured by such a dominant investor.

One such decision was appointing James Murdoch, son of Rupert Murdoch as chairman of BSkyB.  Lots of investors didn’t like this, but Murdoch took the helm of the company.

News Corporation produces its financial statements under US GAAP and has always consolidated BSkyB using the equity method, as an associate.

Under IFRS, it would have been arguable that full consolidation as a subsidiary would have presented a more true and fair view, as IFRS uses more principles based recognition of control than US GAAP.

However, a shock recently came to News Corporation, when it tried to increase its holding from 39.1% to a clearly controlling 61%.

The board of BSkyB refused to agree with the chairman that an offer of 700p per share should be accepted.  The board defied its biggest investor and said that they would recommend refusal of any offer less than 800p.  This appears to have come rather as a surprise to the dominant Murdoch family, who show signs of thinking of BSkyB as their fiefdom.

It’s just a nice example of when apparent control is not control and thus how to be cautious in deciding when to consolidate a company as a subsidiary, even if it generally does everything you tell it to.  If there appears to be a chance of the other investors saying “enough” and refusing to give into your will, it’s not a subsidiary.

The waiting is over. Say goodbye to David Tweedie and hello to Hans Hoogervorst.

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Photo by Seb ter Burg

After a long wait and a fair bit of speculation, rumour and expectation, we accountants now know who the next chairman of the International Accounting Standards Board is going to be.

Now, this might not sound quite as exciting as we’d like to make it sound, but this really is very significant.  When a new pope is elected, crowds throng the Vatican, there is black smoke, followed by white smoke and a general excitement and drama.  Our own global leader was announced by a modest press release from Cannon Street in London (home to the IASB) with a type of modesty that may be typical of our profession.

The successor to Sir David Tweedie will be Hans Hoogervorst, with effect from 1 July 2011.

Mr Hoogervost is a Dutch national, with an interesting background in both academia, politics and business.

Between 1998 and 2007, he held a number of positions in the Dutch Government, including minister of finance, minister of health, welfare and sport, and secretary for social affairs. Prior to this, he served both as a member and senior policy advisor to the Dutch parliament and the ministry of finance. He also spent three years as a banking officer for the National Bank of Washington in Washington, DC.

Mr Hoogervorst holds a Masters degree in modern history (University of Amsterdam, 1981) and a Master of Arts degree in international relations (Johns Hopkins University school of advanced international relations, majoring in international economics and Latin American studies).

This is a varied profile of experience and one that is probably very suited to the man that will take IFRS to the next level of development with the (hopeful) convergence of IFRS and US GAAP.  We think that considerable assertiveness and diplomacy will be required in that task!

Whoever takes over from David Tweedie has a considerable job on his hands.  Under Tweedie’s leadership, IFRS has moved from peripheral relevance to near global domination.  Standards, on the whole, have become much better.  David Tweedie is a tough act to follow.

We wish Mr Hoogervorst every success.  We are pleased that we have the best part of a year to learn how to pronounce his name properly.

How much does it cost to buy your loyalty?

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Last week one of the top policemen in the UK admitted to getting discounted flights for his family by using air miles obtained on tax payer funded flights.

John Yates, who is the Assistant Commissioner of the Metropolitan Police (i.e. the  Greater London Police), is entitled to fly business class on official trips abroad. This enables him to amass significant amounts of air miles which can then be used for free flights in the future.

With a nice corporate governance angle the rules of the Metropolitan Police say that these air miles must be used for future work related flights and not personal ones. In what he claimed was an oversight, Mr Yates however used these air miles for a number of personal flights.

I’m sure it was the last thing on Mr Yates mind but from the Airline’s point of view, the provision of air miles can involve big figures.

The IFRS Interpretation Committee (formerly known as IFRIC) didn’t make many friends when they wrote IFRIC 13: Loyalty Programmes.

Broadly, IFRIC 13 says that when you are given loyalty programme points by a business, they have to recognise a proportion of the total sale to you as a sale of loyalty points.  In other words, they are buying your loyalty, rather than rewarding it.

This means that each sale has to be unbundled into two components – a sale of loyalty points at the value to the customer (which is likely to be very much higher than the cost of delivering the promised service) and the underlying sale itself.

As the loyalty points are used up or expire, the deferred revenue from loyalty points sold is recognised as revenue.

Previously, the accounting policy of most companies had been to recognise loyalty costs as a provision at the expected marginal cost of delivering the service.

This can be a fairly significant figure.  By “fairly significant”, we naturally mean “completely massive”.  Have a guess what the effect was on shareholders’ equity in the restated 2008 accounts of British Airways for implementation of IFRIC 13.

The answer is £206 million.  Nope, that’s not a typo; getting towards a quarter of a billion British Pounds.  Ouch.

We at ExP travel fairly a lot for work and we’ve noticed that airline loyalty programmes have become a little less generous of late.  Maybe the new accounting rules are something to do with this?

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”?

You may recognise this volcano but what about recognising the revenue?

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It seems that a certain volcano in Iceland is going off again.

At the time of writing, a number of UK airports have had to close because of drifting volcanic ash. This, it seems, is likely to be an ongoing problem, especially for more northern European countries.

I have a flight booked in a couple of weeks’ time. I am innately cost conscious and so booked a non-refundable, non-changeable ticket.

Under the Framework definition of an asset and a liability, the airline has received my money and the only obligation that they have is to incur the marginal costs of flying me there, which are likely to be fairly small.  Using the logic of the Framework therefore (and the probable logic of the new accounting standard on revenue recognition that is likely to come through in a couple of years’ time), they would be able to book revenue at the time that the sale was made.

Under the approach of the extant accounting standard IAS 18, however, revenue can only be recognised when the service is provided.  This means that none of my cash is currently in the airline’s profit or loss.

That approach has always seemed excessively prudent to me, as the chances of having to refund the money to the customer has always seemed remote.  I’ve long believed that IAS 18 is in need of replacement with something that focuses more accurately on assets and liabilities.

Mount Eyjafjallajokull has made me wonder whether perhaps holding all revenue in deferred revenue as a liability until it’s sure that it’s no longer a liability might not be such a bad idea after all….

They’re merging with a competitor so surely it must be a merger? In fact it’s not a merger but…

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The troubled US airline industry is going through a period of consolidation.  Consolidation in the sense of companies getting together to reduce their fixed costs per transaction, not consolidation in the sense of producing group accounts.

This article, however, is about group accounts.  The circumstances of the Continental/ United merger do make it look like it’s a voluntary merger and the stock market was conspicuously unsurprised at the news.

The problem is that IFRS 3 requires that for all new business combinations (a new business combination is one that doesn’t arise from a reconstruction of a pre-existing group), an acquirer and acquiree is identified.  This company is then the parent.  Often, a merger happens by a share-for-share exchange and the new parent chooses to change its name to a suitably “merged” sounding name.  But as far as the rules are concerned, one must be the acquirer and the other the acquiree.

So a decision will need to be made about which company becomes the parent. It’s likely that this will be the company with the greater retained earnings.  It’s also likely that formal merger will happen on the first day of the parent’s accounting period, so that a full year of “merged” profits is consolidated.

The group retained earnings of the new group will certainly be less than the sum of their individual parts, since the acquiree’s pre-acquisition profits will not be consolidated.

This may seem harsh if it’s truly a genuine merger, since the idea of pre-acquisition reserves should perhaps be restricted to where there’s a genuine acquisition.  So why is this option not allowed?  You can probably guess – it was subject to creative interpretation of what constituted a merger.  The IASB stated that they believed genuine mergers would probably happen globally about once every five years.

Perhaps Continental/ United is one such genuine merger?

IFRS 9 examinability

Graham Holt, the examiner for ACCA paper P2, has long stated that he wishes P2 to remain a “cutting edge” paper.  This means that he is fond of testing new accounting standards, especially those that are controversial.  We at ExP think that this is both appropriate and fair.

We’ve been asked by a number of people via the “ask the tutor” facility whether the new standard for financial instruments, IFRS 9 could be examined in the December 2009 exam.  The answer is that IFRS 9 is definitely not within the scope of the P2 exam in December 2009, though it will be from June 2010.

HOWEVER, the controversy around some of the perceived weaknesses of IAS 39 would be within the syllabus for the December 2009 exam.  This means that the new rules won’t be examined, but we can easily imagine a question that asks, say, if the number of different classifications within IAS 39 is excessively confusing and asking students to criticise whether people can really be expected to know all of IAS 39’s rather piecemeal rules.  For example, the treatment of transaction costs is rather inconsistent within IAS 39 depending on the initial categorisation of an investment; so that the same investment in the same shares could be required to include transaction costs (if classified as available for sale) or require that those transaction costs are written off (if classified as held at fair value through profit or loss).

Similarly, some weaknesses in IAS 39 that could be “inspired” by the terms of IFRS 9 could be in there, such as whether it really gives a true and fair view to have gains and losses on available for sale financial assets shown initially through equity, yet dividends from those same investments shown in profit.  Wouldn’t it be more sensible to have a uniform treatment for all gains and losses relating to that instrument (as IFRS 9 does).

So the full answer is a bit more complicated than the basic answer.  The examiner can’t test IFRS 9 directly, but he could test it through the “back door” by asking for criticism of the previous rules.

Is it a boat? Is it a plane? No, it’s the world’s biggest non-current asset?

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I just read that Royal Caribbean have recently entered the World’s largest passenger ship – the Oasis of the Seas – into service.  It is enormous, with elevators to carry passengers up and down the 18 passenger decks.  To my old fashioned tastes, it looks rather like a floating housing estate, but I think that’s just age.

Whilst watching an online tour of the ship, I found myself being rather accountant-like about it.  What’s it’s design life and is its useful life going to be shorter?  Do cruise ships go out of fashion before they become too unreliable to sail?  Will it generate more revenues in the early years than the later years?  So should sum of digits/reducing balance depreciation be used instead of straight line?  Of the cost of £800 million to build it, how much is down to the hull of the ship itself and how much to the decoration?  The decoration is no doubt ideal for its target customers just now, but it’s bound to look hopelessly dated in twenty years’ time.  So what’s their policy for “unbundling” the ship into separate components and depreciating each over a different life?

There is much criticism of ship owners sending their decommissioned ships to developing countries to be broken.  As a cruise company, this ship will no doubt not suffer that fate, as to do so would damage the company’s public relations.  So there might be a constructive obligation to decommission the ship in about 30 years’ time at a loss.  Have they recognised that as a liability and discounted to present value?  They should have done, because IAS 37 requires it.

Finally, the interview with the CEO of the company starts by admitting that 2009 has been “horrible” and 2010 doesn’t look much better.  Evidence of impairment right at launch perhaps?  IAS 36 only allows companies to project revenues five years into the future when valuing assets (unless an extension to this period can be justified). Will the global recession be over by then?

So whilst other people see a big ship, I see a floating cocktail of accounting and audit issues.  Is this normal?

IFRS 9 released. This is a biggie.

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On 12 November 2009, the IASB issued IFRS 9 “Financial Instruments”.  This is the first stage of a three stage project that will probably make or break the international reputation of the IASB and its deeply impressive chairman, Sir David Tweedie.

The IASB inherited IAS 32 and IAS 39 from its predecessor, the IASC.  IAS 32 and IAS 39 have been rather markedly unloved ever since their introduction.  IAS 39 in particular has been criticised for taking fairly complicated financial transactions and making them more complicated still with piecemeal rules for different types of transaction.  Although it definitely had its supporters, many people said that the perceived complexity of IAS 39 made it insufficiently understandable by most people to be much real use.

Here at ExP, we believe that IAS 39 has had a slightly unfair press over the years.  It does have its faults for sure, but it also has a decent logic at its core.  The new IFRS (which will come in three parts over the next year; the next two stages to deal with impairments and the third phase to address hedging rules) has a tough job.  Make the rules simpler and it will create loopholes that will be exploited by creative accounting.  Close every possible gap and it will result in an accounting standard that puts on weight each year with minor amendments and ends up not understandable.

The attempts at simplification are honourable.  We’ll wait to see with interest how well they work.  But well done to the IASB for keeping calm in the global financial crisis that many commentators blamed the accountancy profession for making much worse.  They were under huge pressure to make change and they appear to have done a good job in the time they had available.

BA and Iberia to merge. Except not.

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British Airways is a big airline and so is Iberia; the flag carrier airline of Spain.  Both have experienced considerable difficulties in recent years with the global recession greatly reducing revenues and causing operating losses.

For nearly two years, the two airlines were in discussions about merger, in order to share routes and operating fixed costs.  The deal was finally announced in mid November 2009.

The deal is that the two airlines will fuse to create a new business with the working name of Topco. Topco’s capital will be 55% owned by BA’s shareholders and 45% by Iberia’s shareholders. The board will meet in Spain and the CEO of BA will become the CEO of the new business.

For accounting purposes, mergers don’t exist. There is always an acquirer and an acquiree; respectively being the controlling party and the controlled. In this situation, we accountants see it that BA has just done a deal to acquire a new subsidiary, called Iberia.  Assuming that Iberia’s shareholders agree to sell.  And before that happens, there’s the minor issue of BA’s huge deficit on its defined benefit pension scheme to sort out. IAS 19 produces some deeply unattractive pension liabilities on BA’s statement of financial position.

When is a discontinued activity not a discontinued activity?

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General Motors has had a difficult time of late, but things appear to be getting better.  Dogged by poor sales in its core US market, it was forced to raise cash by drastic means.  This involved agreeing the sale of its European subsidiaries (Opel and Vauxhall).  The sale of both to a consortium including Russian banks and Canadian car spares manufacturers. There were legal formalities to complete, but the deal had been announced, largely supported by the German government and looked certain to go through.

At the start of November 2009, it was announced that the board of General Motors had met after a mammoth session and decided not to do the deal to sell its European businesses.  The environment for GM had improved more rapidly than expected and a sale no longer looked necessary.

A discontinued activity is defined in IFRS 5 paragraph 32 as a separate business unit that (a)represents a separate major line of business or geographical area of operations,(b)is part of a single co-ordinated plan to dispose of a separate major line of business or geographical area of operations or(c)is a subsidiary acquired exclusively with a view to resale.  Vauxhall/Opel sounds like it would fit this definition.  It may have been presented as a discontinued activity after being reclassified as held for sale.

It’s unusual for a volte face this big to happen, but it occasionally does. It can produce odd effects in profit, as items are written down to expected sales value and then reclassified at their previous carrying value.

Xerox Corporation and Affiliated Computer Services (BPO world leader) unveil planned new business combination

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Everybody is calling it a merger, but do mergers really exist? And from what date does the combination happen?

Key aspect 1: Determining if IFRS 3 applies and identifying the acquirer.

IFRS 3 applies only to combinations as a result of which an entity (identified as “the acquirer”) obtains “control” of “the acquiree”. Is that the case?

Yes: Xerox is set to acquire 100% of ACS, with ACS expected to “continue to operate as an independent organisation” (branded “ACS, a Xerox Company”) and with Lynn Blodgett (ACS CEO) reporting to Ursula Burns (Xerox CEO).

Key aspect 2: Determining the acquisition date

IFRS 3 requires the combination to be acquisition accounted for at the date when control is obtained. Is the “acquisition date” determinable based on released information?

Not quite: the agreement was signed by the two boards on 28.09.09, but the transaction is “expected to close” by the end of Q1-2010.

Key aspect 3: Recognising and measuring the consideration transferred

IFRS 3  requires consideration transferred to be fair valued at acquisition date, with any transaction costs being expensed and not included as part of the consideration. How does it work in the case?

Xerox is set to pay $18.6 in cash and issue 4.9 shares in exchange of 1 ACS share. Considering share prices on the eve of the deal being announced, such consideration would have amounted to $6.2 billion. However, due to the subsequent fall in Xerox’ share price , the fair value of the agreed consideration went down to $5.5 billion. By the “acquisition date”, the fair value of this consideration may again vary. As to the costs of issuing the new shares raising the $3 billion expected to be needed to finance the deal, IFRS 3 would want them expensed in acquirer’s books and NOT considered as part of the consideration paid (and, therefore, potentially capitalised as goodwill).

Are accountants to blame for the global crisis?

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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.

Hard times for deferred tax

Deferred tax assets are only assets if they are expected to generate an inflow of benefits.  In the current environment, impairments are hurting lots of companies; one of the World’s most high profile electronics giants included.

In January 2009, Hitachi Corp (New York and Tokyo listed) issued a statement aimed at warning capital markets about group’s intention to book a valuation allowance in the amount of 200 Yen billion against its deferred tax assets as at 31/03/09.

IAS 12 requires recognition of deferred tax assets (that is, “receivables” due from the tax authorities, as arising from the temporary deductible differences between the accounting and the tax bases of reporting entity’s assets and liabilities as at the reporting date) only if the reporting entity can prove recoverability of such assets, in the form of tax savings by reducing taxes payable in the future.  This is done by deducting calculated temporary deductible differences at the current reporting date from future expected taxable profits. If such future profits can no longer be reliably foreseen (and that is supposed to happen pretty often in economic downturn times, as it was with Hitachi’s case), any previously recognised deferred tax assets are impaired, with the consequent adverse effect on the entity’s reported net income for the year.  This makes bad times worse, as disappointing profits are made worse by tax asset write-offs.  Ouch.

As the columnist Paul Davis put it in the one of the September 2009 issues of the “American Banker” magazine, “’Deferred Tax Assets’ May Be Next Bottom-Line Hit”