Defending the Indefensible
By Charles Hattingh
I find it fascinating how accountants react differently to a situation. I have been studying the reactions to my criticism of the new standard on related party disclosures, which requires a reporting entity (RE) to disclose transactions between related parties (see last month’s journal). If RE has a holding company (H) which has another subsidiary (FS), sales between H and FS will have to be disclosed in the financial statements of RE. When discussing this in our workshops, I get a variety of reactions. I have listed some of thembelow.
1. The sheep syndrome (follow without questioning): “Tell me what I must do and I will do it. Do not waste my time with telling me that you do not agree with the standard.”
2. The puppy dog syndrome (sees the good in everything so does not criticise): “The disclosure of the sales between the holding company and our fellow subsidiary is important to our users as it could indicate that we are at a competitive disadvantage.”
3. The meercat syndrome (a master at ducking and diving): “If we ask our holding company to unbundle our fellow subsidiary, the related party relationship will be broken and this disclosure will then not be required.”
4. The hyena syndrome (finds everything hysterical): “You’ve got to be joking.”
5. The rotweiler syndrome (goes for the throat): “The standard is clearly wrong.”
Some other comments I have had are:
1. “Surely if in doubt one should look to the objective of the standard, which only requires transactions between the related parties and the entity?”
2. “How will we get the information? The holding company is not obliged to give it to us.”
But what I find depressing is that few accountants are prepared to look at such a problem objectively. Is this because we have been trained not to question authority? When I have engineers in my workshops, they challenge anything that is, in their view,not logical. I believe that we must look at our educational system to find out why we are so passive.
I have been battling over the years to get what I believe are serious defects in our accounting standards rectified. No one takes any notice. However, in the latest round of the newly published standards some problems have been addressed, e.g. that negative asset called negative goodwill has at last been killed off and the option of revaluing assets of a subsidiary on consolidation only to the extent of the holding company’s share has been deleted. However, there are still many flaws that need to be addressed. I have listed my top ten stupidest things in GAAP prior to the publication of the standard on related parties. I do not expect the authorities to do anything about them (I really did try to get them sorted out at the time) so the motive of this exercise is to have some fun.
1. Classifying a revaluation of a long-term strategic equity investment as part of headline earnings.
The concept of headline earnings is “trading profit” but the profession, for some inexplicable reason, is insisting that headline earnings be contaminated by this profit or loss. It is interesting to note that not all listed companies are following this rule (the JSE’s GAAP Monitoring Panel should take note).
2. Having to provide for deferred tax at the company tax rate on the revaluation of an office building.
Office buildings are not tax deductible so the carrying value of the building represents the after tax amount. To have to provide for deferred tax on the after tax revaluation is clearly wrong. When we originally queried this with the standard setters their argument was that they did not want too many exceptions to the rule as it would undermine the standard. Mistakes like this undermine the standard!
3. Having to provide for deferred tax on the full value of an administration or retail building in a business combination.
At the time I tried to get this rectified. Our local people said that the solution was to gross up the building by dividing it by (1-tax rate). With respect, this was a silly way to solve the problem. We should have rectified the standard! This problem is not confined to buildings. The problem also exists when intangible assets that are not tax deductible are acquired as part of a business combination.
4. Forcing companies to comply with unrealistic hedging criteria.
By trying to do the work of the auditors, the standard setters have made it almost impossible to comply with the hedgingcriteria thereby forcing companies to produce results that do not meet the test of economic reality.
5. Embedded derivatives in supply agreements where the currency is not your own or the other party’s.
If a SA company enters into a supply contract with a US company in dollars there is no embedded derivative but if the contract is entered into with a Japanese company in dollars there is. This requirement is watered down in the latest version of the ongoing financial instruments saga.
6. Not allowing the loss on foreign exchange to be added to an imported asset after control of the asset has passed but insisting that the loss on foreign exchange between the date of the transaction and the date control of the asset passes be added to the cost of the asset.
7. Allowing post-retirement defined benefit actuarial losses to be left off the balance sheets of companies.
There are moves afoot to rectify this in the near future.
8. Building the risk factor into the rate used to discount environmental obligations.
The effect of this is that the higher the risk, the lower the environmental provision.
9. Allowing companies to fair value private equity holdings and taking the resultant gains to income.
If you have ever done a valuation of an equity investment for which there is no active market you will know that the range of calculated values can be material. Companies are having a ball padding their profits with such revaluations.
10. Requiring a small farmer in the Karoo who operates through a company and only prepares his financial statements for tax purposes to comply with IFRS (sorry, to mention this but it is on my list).