Civil complaint against Ernst & Young

Jan 6, 2011

A civil complaint was filed recently by Andrew Cuomo, the outgoing New York attorney general, accusing Ernst & Young of helping Lehman Brothers mislead investors. The state claims Lehman’s auditors aided in a fraud, using Repo 105 transactions to make the books look healthier than they actually were.

Ernst & Young obviously maintained that they did nothing wrong. Well technically they are right, they did comply with Generally Accepted Accounting Principles, or GAAP.

The crux of the case should be the intent. Recently there has been news about various organizations being caught in accounting fraud, and in most cases the auditors had signed off on the financial statements. Should the auditors be responsible for just ensuring compliance with accounting rules or should they be held accountable to ensure that their clients’ intent is not to hide material facts.

This definitely is a case  accountants all over the world will keep a close eye on. This might define how accounting world would function in the future.

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TUI says adieus to KPMG

Jan 3, 2011

TUI Travel, has decided to say adieus to their auditors KPMG. The move comes soon after the company had to take a write-down of £117 million, forcing the company to restate their 2009 results. The company has decided to go ahead and replace the outgoing auditors with PricewaterhouseCoopers.

TUI maintains that they have good working relationship with KPMG. KPMG on the other hand said that relations with some of TUI’s directors had become more strained after the incident. Definitely in this case TUI is not letting bygones be bygones.

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Demand Media IPO on hold

Jan 3, 2011

Way back in August of 2010, Demand Media, an online content creator filed for an IPO in the hope of raising $125 million. But as of end of December, it was still answering questions from government agencies about their accounting practice, specifically around how they expense their costs of content.

Most media companies, online and off, immediately report the total costs of content creation. But Demand spreads the costs over five years, which leads to a higher net income or lower net loss for the company. Demand’s rationale is that the writers’ content will generate revenue for the company over multiple years, so it shouldn’t have to recognize the costs upfront. And so they spread the costs over a period of years.

DemandMedia is not the only party waiting to get a resolution; other online content creators are waiting too. If this accounting principle is accepted by the government agencies, then it might become a norm in the industry as this definitely boosts the bottom line for the companies.

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Move to IFRS leads to losses for Power companies in India

Jan 3, 2011

The adoption of IFRS beginning April of 2011 will have a big impact on both the Income Statement and the Balance Sheet of power companies in India. Under the present Indian GAAP, rate regulated assets/ liabilities are allowed to be recognized, so companies have recognized as an asset or liability- tariffs, fuel adjustments and advances against depreciation.

With the adoption of IFRS, such assets or liabilities will have to be removed from the financial statements. In terms of numbers the initial impact on account of these regulatory assets under IFRS can be as high as Rs.745 crore in case of Tata Power and Rs.1,034 crore for Reliance Infra.

This issue is not centered only on India. This IFRS rule affects power companies worldwide. Just as an example the regulatory assets and liabilities for the electricity companies in the US is estimated to be $675 billion and $450 billion, respectively, in 2007.

For the convergence and standardization of the accounting standards, such anomalies will have to be taken into stride.

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New rules for insider trading violations and audits of internal control

Dec 20, 2010

The SEC issued two rules in September 2010, in order to implement the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act). The rules affect the payment of bounties for revealing insider trading violations and requirements relating to audits of internal control over financial reporting.    

First, the SEC rescinded rules which authorized the payment of bounties for providing information leading to the recovery of civil penalties for insider trading violations, which were previously authorized by the Insider Trading and Securities Fraud Enforcement Act of 1988. In its place, the Dodd-Frank Act established a broader program for monetarily awarding whistleblowers. The new program authorizes the SEC to award persons who provide “original information” that leads to the successful enforcement of certain judicial or administrative actions. Potential awards range from 10% to 30% of collected monetary sanctions. Unlike the former insider trading bounty program which authorized awards only for violations of insider trading laws, the new program authorizes awards for the violation of any federal securities law.

The SEC additionally amended certain rules to conform to the new Section 404(c) of the Sarbanes Oxley Act of 2002 (Sarbanes-Oxley), added by the Dodd-Frank Act, which exempts non-accelerated filers from having to include in their annual reports an independent auditor’s attestation report on internal control over financial reporting. Accordingly, the SEC amended Item 308 of Regulation S-K to require filers to include in their annual reports the disclosure regarding this attestation report only if such an attestation report is actually included in the annual report. Rule 2-02(f) of Regulation S-X similarly clarifies that audit reports need not include an assessment of a non-accelerated filer’s internal control over financial reporting.

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Convergence Project still on track

Dec 20, 2010

Recently the Financial Accounting Standards Board and the International Accounting Standards Board said they were on track to finish writing the new accounting standards for financial instruments, revenue recognition, leases, comprehensive income, and fair value measurement by June 2011 or earlier. The IASB is also on target to align its disclosure requirements for derecognized assets and other off-balance-sheet risks with U.S. rules and to finish its updates for consolidations and insurance contracts by the same date.

Due to the push to get these projects completed by mid 2011, some of the other joint projects the two boards are undertaking have been pushed back.  Those projects include an effort to reorganize the entire presentation of financial statements, a new standard for financial instruments that have characteristics of equity, and new rules for emission trading schemes and the consolidation of investment companies. The boards also are putting off further work on their conceptual framework.

Even though some projects are getting pushed back, there is definite headway being made on some of the key convergence standards.

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India on track for adoption of IFRS

Dec 16, 2010

Even thought the Indian version of the International Financial Reporting Standards (IFRS) has been altered here and there, the country is all set to implement the standards come April 2011.

In the first phase, companies on the Indian stock exchanges – Nifty 50 and BSE Sensex, firms whose securities are listed on stock exchanges outside the country, and all those having a net worth of R1,000 crore, would switch to the new accounting system.

Insurance and banking companies, however, would be required to migrate to the IFRS methodology from 2012, the circular said.

The Institute of Chartered Accountants of India (ICAI) has also set up a group, which includes members from the finance ministry, for identifying tax issues that may arise from the convergence issue. The group has prepared a draft report identifying certain options that could be adopted to achieve tax neutrality.

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IFRS adoption leads to increased net worth for Coal India

Nov 22, 2010

The move to adopt the International Financial Reporting Standards will boost Coal India Ltds’s net worth by $2.4 billion.

 The company adhering to the old accounting standards has on its books a $2.4 billion provision on account of the overburden removal reserve. This reserve was maintained as Indian mining accounting is based on mineable deposit and expected lifespan of a mine. In the initial period, the cost of mining was less, but it gradually increased as mining went deeper and thereby leading to a huge reserve balance.

 With the adoption of IFRS, the mining cost can now be calculated based on actuals and no provision for future mining is to be made. So the reserve can now be released leading to an increase in the net worth.

To put things in perspective, the present net worth of the company is $6 billion; the change to IFRS would bring the net worth up to $8.4 billion.

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Bullock County Audit reveals material weaknesses

Nov 20, 2010

A recent audit done by the State Board of Examiners revealed that the Bullock County Commission, Alabama had a number of material weaknesses in their financial reporting. The audit covered the 2008-2009 fiscal years.

The key issues uncovered were relating to the funds maintained by the county, expenditures related to different funds and lack of compliance of the competitive bid law in some instances.

More specifically the Commission did not maintain a current and accurate listing of amounts due to individuals held in the fiduciary fund, excess land sales fund and the land redemption fund. The Commission also put through the Capital Improvement Fund expenditures of the nature of general repairs, maintenance and operations that are not allowable expenditures for this restricted fund. Some of the expenditures from this fund were not supported by adequate documentation. Also the Commission pad at least $61,000 for supplies and $24,000 for food for the Jail without letting bids as required by the Alabama Competitive Bid Law.

Auditors found accounts payable and expenditures were overstated by more than $1 million in the general fund, and they found similar issues in other funds.  Auditors also questioned some leave and comp time reports.

The Commission blamed the accounting errors on switching to a new computer system and promised to reevaluate the bidding process.

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Ahold fraud

Nov 17, 2010

In February 2003, the Amsterdam based supermarket operator, Ahold announced that it had inflated earnings by atleast €391M ($500M) at its wholly owned US food service subsidiary. Apart from that the company also improperly consolidated revenues from joint ventures. The total effect of the fraud was  €1bn in false profit statements. The fraud was carried out both in US and Europe.

The company’s auditor’s, Deloitte claimed that they were not able to catch the fraud because they were given false paperwork!

In May 2006, three years after the fraud came to light, three ex-Ahold bosses received suspended sentences and €670,000 worth of fines from a Dutch court in May 2006. The executives were found guilty of large scale accounting fraud from 1998-2003.

An interesting statement by the Judge in the trial summarizes the sentiments of all effected by frauds all over the world. Judge Frans Bauduin said the three prosecuted men “have damaged the good reputation of Dutch companies in general and Ahold in particular” and “betrayed the confidence that shareholders…placed in them“. It is so true of any fraud that happens anywhere in the world.

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VeriFone restates their financials

Nov 17, 2010

In 2009, Silicon Valley technology company, VeriFone settled charges with the SEC concerning the company’s restatement of quarterly financials. In 2007, SEC alleged that the company had released materially false quarterly reports for the first, second and third fiscal quarters of that year.

The allegation states that VeriFone’s former supply chain controller, Paul Periolat, made improper modifications to inventory so that the company could meet its previosuly announced earnings guidance. Periolat allegedly manually adjusted the inventory of a subsidiary for the first quarter of 2007, even though he was aware that the reported inventory was correct. The SEC alleged that Periolat improperly manually adjusted inventories again in the second and third quarters of that year.

On August 19, 2008, the company released the restated financials. Cumulatively, operating income for the three quarters decreased from $65.6 million to $28.6 million, an overstatement of 129%.

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The case of phantom customers

Nov 11, 2010

A recent report by Muddy Waters ,a small research firm , about RINO International Inc , a desulfurization and other environmental equipment provider to Chinese steel mills, is an interesting read. According to Muddy, RINO’s business is a complete sham. The report states that the company has inflated its earnings, their revenue for 2009 was only $11M or 94% lower than it reported in the US. Many of the company’s customers relationships are non existent.

The report goes on to say that the company’s management is using the company’s resources for personal use, e.g. management “borrowing” $3.2 million to purchase a luxury home in Orange County, CA the day that RINO closed its $100.0 million financing.

Muddy is not in clear waters either, they and some of their clients actually have a short position in RINO’s stock. So if the stock price goes down Muddy and some of its clients stand to have significant gains.

RINO in their defense issued a press release saying that it will be investigating Muddy Waters’ claims and reaffirmed that it will release third-quarter earnings on the 15th.

This definitely will be an interesting topic to keep an eye on. If Muddy’s claims are found to be incorrect, where does it leave Muddy’s credibility; but on the other hand if Muddy’s claim’s are correct, then watch out investors!

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Lease accounting convergence

Nov 11, 2010

Another step towards convergence of the accounting standards. On August 27, 2010, the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) jointly published an Exposure Draft, outlining proposed major changes to Generally Accepted Accounting Principles (GAAP) for leases. The changes would modify GAAP accounting standards to require the capitalization of most leases now treated as operating leases.

The changes are intended to provide greater disclosure in GAAP financial statements, since operating leases are not generally reflected on the balance sheets of either landlords or tenants, and to harmonize GAAP treatment of leases with international accounting standards.

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The bug in the accounting at Computer Sciences

Nov 10, 2010

In their 10Q filing, Computer Sciences Corp. disclosed that it had found some accounting irregularities in their Nordic business unit. The issue amounts to a “material weakness” in internal controls over financial reporting. The company took a hit of $30 million to their Income Statement in their fiscal quarter two ended October 2. There is more to come, there will be another $40 million charged during the first half of FY2011. These charges were related to prior period but due to deficiencies in the internal control system were not discovered up until now.

The company said the charges reflect “accounting errors and the misapplication of internal accounting policies and U.S. GAAP, as well as from accounting irregularities in the Nordic region, principally affecting prepaid accounts and outsourcing contract costs.”

Computer Systems is developing a remediation plan, including replacement of certain managers, strengthening controllership responsibilities, improved monitoring controls and oversight, and increased discipline associated with account reconciliations. Hopefully the issues are only in their Nordic business unit and hopefully this one time charge will clear all such issues and there are no more waiting to be uncovered.

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UK getting set to adopt IFRS

Nov 8, 2010

The Accounting Standards Board (ASB) is ready to incur 78.9 million pounds in order to move to the International Financial Reporting Standards (IFRS). The new system would introduce across the business community, but the ABS insists the cost will be well worth it.

The rule book will be reduced from 2,000 pages to 400. The scope for auditing errors will also be reduced. The new standards would modernize and simplify the accounting system which would provide make it easier to read financial statements and benefit the investors and the market in general.

The system had been scrutinized and debated for 6 years and is expected to be fully in place by summer 2013. Transition costs for companies of medium to large size are expected to average 80 million pounds.

One question that arises associated with the changes that different economies are trying to implement to their accounting standards is whether it is the right time. With the global economy being fragile would it move the resources from strategizing about the future of the company to getting the books compliant with the new standards.

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