Parents Unite

Parents Unite

An Analogy

The great granddaughter of Freud (GGF) developed a set of drums which, if played properly, was supposed to realign the neurons in the minds of children, thereby improving their IQs. She wrote a set of instructions to go with the drums which forbade tampering with their design and applied for the necessary patents. This idea was embraced by parents and governments alike and sales of the drums soared. They became known as Neuron Alignment Drums, or NADs for short. SORNADS (Societies for the Regulation of Neuron Alignment Drums) were formed around the world and inspectors from SORNADS instructed parents that if they stopped their children from playing these drums they would be accused of child abuse, with possible jail sentences.

The children took to this idea like fish to water. However, because of the speed at which the idea caught on, the drums were flawed causing hearing loss in children and parents alike and because children were not trained in their use, the drums became instruments of entertainment causing noise pollution in high density housing complexes to the annoyance of neighbours. ENT specialists became inundated with cases of hearing impediments. Schools, universities, commerce and industry started experiencing anincrease in applicants with IQ’s at retard levels.

Parents and neighbours pleaded with the various SORNADS to do something about the problem with no success. Representations were made to Government and after many years of procrastination a new body was formed called the Regulatory Body for the Use of Neuron Alignment Drums or REBUNAB for short, which includes representatives from thegovernment, children, parents, neighbours, commerce and industry and ENT specialists. REBUNAB has embarked on a twenty year project to try to solve the problem.

Accounting Standards

If you substitute GGF with IASB, NAD with IFRS, SORNADS with SAICA, REBUNAB with IRBA, the children with auditors, the parents with the preparers of financial statements, the neighbours with financial statement users and the ENT specialists with people like me who spendour lives trying to help the preparers and uses unravel the chaos being caused by IFRS, you will see where this is leading. And, believe me, this is not an exaggeration. The state of IFRS is in crises and something needs to be done urgently. The only body that is, hopefully, independent enough to act on behalf ofpreparers and users is the newly formed IRBA. Let’s see if they are up to the challenge.

Here are examples of the irritants being experienced by preparers at present. The problems are caused by flaws in the standards or by auditors not being trained in the art of interpretation. The issues of providing for deferred tax on the revaluation of buildings and straight lining rental have been dealt with in previous articles.

Disclosing related party transactions between subsidiaries

A holding company has 30 subsidiaries which have numerous dealings with each other. These transactions and the resulting balances cancel out on consolidation. The auditorsare insisting that the company must disclose full details of each transaction and each balance in the company’s separate financial statements.

Consolidating borrowers

A bank lent money to a close corporation. The loan agreement contained the usual covenants to protect its investment. The auditors are insisting that the lender must consolidate the financial statements of the close corporation because it “controls” the borrower. (Did you read this you big bank types?)

Taking a loss on an increase in price after the sale is made

A farmer sold maize for future delivery to a co-operative society. The price increased after the sale. The auditors are insistingthat the farmer take a loss because he could have got a higher price had he waited.

Taking a loss on a sale when no loss will be incurred

A farmer entered into a long term maize supply agreement with a miller at a fixed price of R900 a ton increasing by the CPIX each year. The cost to the farmer is R650 a ton. The advantage of this agreement is that it secures the supply of the farmer’s product for years to come. The market price at the date of the contract was R1 000. The auditors are insisting that the farmer take a loss of R100 a ton in respect of all full future sales. This would result in a loss and a liability of more than the farmer’s equity. When the financiers see his balance sheet, funding will be withdrawn and the farmer will be out of business.

Expensing the cost of buying back an entity’s own shares

A company entered into a put option to buy back its own shares at the market price on the expiry of the put. The auditors forced the company to expense this “cost”.

Discounting normal trade debtors and creditors

A company buys and sells goods with normal terms being 60 days to pay. The auditors are trying to force the company to discount its trade debtors and trade creditors!

Not permitting the recognition of a sale where a guaranteed buyback is given

It is the practice in the motor industry to issue a put option to the financier on the sale of the vehicle to enhance its security value. Seldom do these puts result in a loss to the dealer as they are conditional upon the vehicle being in a condition that ensures a profit on resale. The auditors argue that the significant risks and rewards of ownership have not passed so refuse to allow the dealer to take the sale.

Consolidating a close corporation from whom property is rented

A private company rents land and buildings from a close corporation whose only member is the major shareholder of the company. Because the parties do not want to straight-line rental received or paid there is no rental agreement between the two parties. The auditors say that the assets and liabilities of the close corporation must be consolidated by the company as the close corporation meets the definition of a special purpose entity or, failing that,the company must apply IFRIC 4.

Raising an embedded derivative liability on a sales contract

A local company entered into a contract with an overseas customer to convert imported raw material to finished goods. The selling price of the finished product was fixed at $100 per unit. The cost of the raw material fluctuates but is not expected to be higher than $50 per unit in the foreseeable future. The cost of conversion is R60 per unit. Because the contract with the customer was signed when the rate of exchange was R10 to the dollar (the rate is presently R6) the auditors forced the company to raise a liability of R60m being the difference between R10 and R6 times the contracted quantities discounted over the supply agreement! The auditors cannot explain to whom this R60m is owed but argue that IFRS requires this embedded derivative to be raised.

Share Appreciation Right

A listed company issued share appreciation rightsto its staff. The idea was that staff would be paid out the excess of the market price over the exercise price of R10 three years after entering into the SAR. Before the end of the year the share price collapsed to R2 per share. Management is of the opinion that there is no possible chance that the market price will recover to over R10 in the next two years. The auditors forced the company to raise a massive liability for the cost of the SAR because some “expert”arrived at a positive value for the option using an excessive standard deviation. When the auditors were asked whether this “liability” would be paid to anyone in the future, they replied: “No, it will be recycled back to profit or loss.” (Do you understand why I get so frustrated?)

Writing land and buildings down to zero

A share block company was formed to house extremely valuable residential property for its shareholders. The shareholders have the right to live in the property rent free. The preparer wants to keep things simple and leave the property in the books of the share block company at cost. The shareholders would like to see the value of the property in the financial statements to assess their true worth. The auditors are trying to force the company to write the property down to zero because it does not earn anything, despite the fact that the property could be sold tomorrow at its fair value.

Residual Values

A mining company keeps its assets until the end of their economical lives, at which point they are scrapped. The residual values, if any, are immaterial. The auditors insisted that the company pretends that it can find buyers for the assets at the end of their “useful”to arrive at their residual values.

In Conclusion

Standard setting is not the domain of the auditors. Auditors are assuming this responsibility without consulting preparers and users and enforcing their will through the threat of qualification. The result is that financial statements are becoming a meaningless representation of the financial position and performance of reporting entities. As a temporary measure and until, hopefully, things improve I am trying to encourage preparers in South Africa to go the US route of presenting two sets of financial statements, onebased on IFRS as seen by the auditors and one based on substance and economic reality as seen by the preparers with a reconciliation between the two. In the USusers analyse both sets and make up their own minds. I have read that analysts find management’s take on the matter more useful to their needs. If this approach is followed, it will either have the effect of undermining IFRS or cause the standard setters to reassess their standards. And it will, without doubt, wake up the analysts to the realisation that IFRS is not the solution they have been searching for all these years.

I find it sad that preparers do not resist applying accounting standards that they know are wrong. Maybe it is the legacy of the past that has instilled this passive acceptance of authority without questioning it. We have become like a bunch of sheep following a ram that has no idea where he is going.

NOTE: I am not prepared to get involved in technical arguments in respect of the above examples. They were given merely to illustrate that we need a formal independent body to resolve the IFRS conflicts that are raging between auditors and preparers to the detriment of users.

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