May 2000: Let's call a Spade a Spade
The definition of fraud in my dictionary is: "criminal deception, act of this kind, person or thing that deceives, deceitful". Do you commit fraud, i.e. are you deceitful? Consider:
- Fudging safety records in a nuclear facility stating that proper checks have been carried out.
- Understating or overstating numbers of deaths of civilians during a war.
- Understating the effects on the well-being of the earth from industrialisation, deforestation, over fishing, etc.
- Understating or overstating rape statistics.
- Overstating assets/understating liabilities in an enterprise that is in financial difficulties.
- Understating assets/overstating liabilities in a profitable enterprise for tax purposes.
- Manipulating the financial position when reporting to a regulating body.
- Understating your personal income or overstating your business expenses when reporting to SARS.
- Falsifying your whereabouts last night to your partner.
Why do people perform deceitful acts? If you think about it, it is usually for personal gain (power, pleasure, greed) at the expense of some other person or group of persons. If you really think deeper, deceit is usually carried out by those who are incompetent - getting what you want through deceit is often easier than having to work for it.
My first experience of the "real world" was my first write-up after leaving school (bookkeeping was one of my subjects). The client was an agent for a well-known product and a judge on the income tax court. I discovered that he was claiming all sorts of personal expenses in his company. When I confronted my boss with this information he said: "Son, lesson one in life is that the client is king."
After a lecture one night a young women who had just completed her university studies stayed behind to tell me this story: She had discovered a fraud at a client and, during her lunch period she investigated it and after work she drafted a report on the situation. The next day she proudly presented her report to her boss. He read it, tore it up, threw it in the wastepaper basket and said: "You did not see this".
In the work I am doing at present (spreading the word of GAAP), I am being confronted with this kind of deceit daily. Because of my confidentiality pact with the people I work for, I cannot reveal specifics, but it pervades the business sector in our country. The good news is that the Government is starting to do something about it, SARS is turning up the heat, the FSB is bringing pressure to bear and the bigger auditing firms are starting to get tough on their clients.
A major deceit has, in the past, been understating the assets and liabilities of an enterprise by not capitalising what are, in reality, finance leases. A new statement on leasing is on the way and the good news for those trying to figure out how a company has really performed is that the classification rules have been strengthened. The clients of leasing companies (and the leasing companies themselves) are struggling to work out ways of getting around this statement. The bad news for them (and the good news for the users) is that the wording of the statement has been strengthened. You will have to be ultra-deceitful if you want to get around the new wording or you will have to restructure the lease such that the risks are substantially with the lessor, something the banks cannot afford to do.
The RSA version of this statement differs from the IAS version in that two important paragraphs have been black lettered:
"Whether a lease is a finance lease or an operating lease depends on the substance of the transaction rather than the form of the contract."
"A lease is classified as a finance lease if it transfers substantially all the risks and rewards incident to ownership. A lease is classified as an operating lease if it does not transfer substantially all the risks and rewards incident to ownership."
If you use an asset and bear the risks of obsolescence and under-utilisation and get the rewards from the use of the asset and you cannot, without penalty, return the asset to the financing company, this asset is a finance lease and should be capitalised. This is, of course, if you are not trying to be deceitful. If you are, you are going to use all sorts of arguments such as "but the risk of fire has been insured". If you ensure your assets, do they no longer belong to you?
The lament I am hearing now is: "Our bosses have set a profitability target of 20% p.a. on operating assets - by capitalising these assets our target is going to be more difficult to achieve." You have three choices: (a) Educate your bosses that 20% on assets employed is not attainable. (b) Pull finger and start improving marketing, productivity, etc. and achieve your targets. (c) Argue that the assets you are using should not be accounted for as such. Which is the easier route? You do not want to be fired and, hey, improving marketing and productivity is tough, so take the deceitfully easy way out and remove the assets (and funding) from your balance sheet!
Dear Uncle Charlie,
Our company made a loss of R5 million in one of our departments and we have decided to debit this loss to our revaluation surplus on assets. We are worried that if we take this loss to the income statement our shareholders will be upset. Would you be happy with this treatment?
Worried
Dear Worried,
The only reason you seem to have a problem here is that you were brought up in a society that does not frown on fraud. You know that this entry is not in accordance with GAAP. You know why you are suggesting this entry - it is to protect your job. You know that unsuspecting investors will be buying shares in your company on the strength of your financial statements and will, as a result, ultimately lose. What is more important to you: your job security or your soul?