Going Concern - are you sure your firm will survive the next 12 months

A FEW months before XL Leisure Group, Britain’s third-largest tour operator, filed for bankruptcy in September, leaving thousands of holidaymakers stranded, it issued a set of accounts, signed off by its auditors, that gave no hint it was about to go bust. Such experiences haunt auditors as they grapple with year-end accounts in the cruellest economic climate most have ever experienced. “Companies and their auditors have got to get used to the idea that nothing is as it used to be,” comments Will Rainey, a partner at Ernst & Young, one of the big-four accounting firms.

The problem is that year-end accounts are prepared on the basis that a business is a “going concern”, ie, that it will operate for the foreseeable future, or at least 12 months after the reporting period. That judgment is made by the board of directors, and auditors have to agree with it.

The difficulty they face is that most companies fund their operations in part through borrowing, which can stretch from simple overdrafts to huge syndicated loans. Each year, auditors will often seek letters from their clients’ bankers reassuring them that they will renew lending facilities in the ordinary course of business. But this year many banks may well refuse to write those letters because they do not want to commit to new lending. It will lead to some difficult judgment calls on the availability of funding next year, Mr Rainey says.

According to international standards, directors and auditors usually have three options with accounts: they can prepare them on a going-concern basis, which is standard but might expose them to charges of negligence if they are wrong; if they do not believe the business is a going concern, they must prepare the accounts on a break-up basis; or they can express some doubts about the company’s future, but still prepare the accounts on the going-concern basis. (Britain’s Financial Reporting Council has suggested a fourth alternative, that would express “serious doubt” about the ability of the company to continue as a going concern. But auditors say this may add to confusion.)

The temptation this year will be to express some doubts about funding uncertainties, but auditors realise that if they do that too widely, the caveat will become meaningless. Steve Priddy, of the Association of Chartered Certified Accountants, says that the onus will be on directors to be frank about any worries, even when they consider the firm a going concern. But if banks do not want their most creditworthy clients to suffer, they should be a bit bolder, too. After all, many now have the explicit backing of their governments. So they can afford to be a bit more public-spirited in these peculiar times.

Source - the Economist 

Lease GAAP unusual questions- software licences can they be classified as leases

Various companies very often source software licenses from third parties for their operating systems and more often than not these are bundled together with AMC & software support contracts.

Contracts for core accounting and operating software typically run over a period of time say 3-5 years and many a times accountants take the annual cost  on the contract straight into SG&A.

Well for those companies who wish to improve their EBITDA or LBITDA (coined only for the recession "L"= losses), they can take recourse to lease accounting.

Wait a minute doesnt, lease accounting straight away exclude licenses from its scope under its very definition, co-incidentally all GAAP's (US/IASB/ICAI) have this written in their very first page, so where's the scope.

Well i scratched my head and could find all about two reasons

a) the exclusions cover licences on copyrights, trade licenses, oil exploration rights.... most of these licenses, typically have no shelf life and appreciate over a period of time or rather are intangibles with no finite life, these can be construed that lease GAAP excludes from its scope only those licenses, which dont have a shelf life and their values appreciate over a period of time.

b) SOP 98-1 (Accounting for cost of software- AICPA pronouncement) provides that companies must analogize to FAS 13 (Accounting for leases), whenever  an asset is acquired as a result of a software arrangement and must test for the 4 criteria to classify them as an operating or a financial lease.

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Point (a) may or may not be that convincing but if you can analogize SOP 98-1 to your GAAP, then its worth a try.

Now that we have figured out that software licenses can be classified as leases, all you have to do is break down your value of the contract into cost of software licenses, cost of support and AMC (based on the fair value approach) or rather apply the rules on embedded leases (read my blog on embedded leases).

Its strange but when you sit down and compare GAAP'S across the world, most of the substance remains the same, though may vary in form.

IFRS amendments on Fair value - Its trinity's turn

With Neo (banks) and Smith (FASB) read earlier articles on fair value, its time to introduce TRINITY (IFRS)

With the FASB taking a lot of flak for its standard on FAS 157 and being forced to make some amendments, IASB in response also decided to make certain amendments to IFRS 7 and IAS 39.

The amendments to IAS 39 introduces the possibility of reclassification of investments  from a "held for sale" assets classification to a "held to maturity." 

• The switch eliminates the need to record the instruments at fair value (at market prices), and;
• instead allows companies to record these instruments at historical costs unless there is a permanent impairment. (explained with an example at the bottom of the blog)

Reclassifying the assets to held to maturity will be a big boost for banks, which now can continue to hold these investments at book value and only test for impairment rather than marking them to fair value prices in distressed market conditions.

The only glitch or rather advantage which firms applying IFRS will have over USGAAP, is that the reclassification can be done retroactively from July 1, 2008. This will give bank managements to essentially 'cherry-pick' which instruments to reclassify and, in some instances, avoid the recognition of markdowns on assets that declined in value since that date.

IAS 39 was deemed a stronger standard than FAS 115, for the fact it did not allow reclassification of investments. I feel that, the current move has given a silver lining to a lot of  companies to reclassify those investments retroactively which have been worst hit in the financial turmoil (Q3) and will have a very minimal chance of their appreciation in the next year (even over their book value).

This reclassification will enable companies to restate their Q3 earnings and boost Q4 earnings. Accountants who have an eye on the stock markets and have a punting trait in them will be much in demand to cherry pick these investments to boost their companies growth. 

For instance, consider a bank has an equal portfolio mix of real estate investments and FMCG stocks, say $50M each and both were classified as held for sale.

• On July 1, 2008, the value of the real estate portfolio was $30M and FMCG stocks were $40M 
• Losses recorded on account of the fair valuations in the company are $30M ($50M-$30M for real estate) & ($50M-$40M) for FMCG
• Your company's investment analyst has forecasted a bearish view on real estate stocks, while being bullish on the FMCG stocks for the next year
• Given this view, accountants reclassify only real estate stocks from held for sale to held for maturity, thereby restating their values back to $50M and reversing the $20M loss in the books.
• Total revised losses on account of the reclassification are now $10M (on FMCG stocks). There is an earnings boost to the extent of $20M (real estate reclass)  for the current quarter of reclassification.
• If the FMCG stocks rebound in the next quarter, these losses will also reverse on the basis of their fair valuations.

A smart accountant will retain the losses on the FMCG stocks as "rainfall provisions" to be utilised in the next quarter. In case the stock prices rebound, the losses reverse, if the economic crisis deepens, he still has the option to reclassify this investment to held for maturity and thereby giving his company an earnings boost in a deeper economic crisis.

Ain't IFRS getting accountants to be more creative and albeit triggering a sense of punting in them.

How not to Recessionise your job - Catch 22 pointers

Its Q4, and its that time of the year when yankee FPA's are sitting alongside with all business heads to shore up 2009 numbers albeit on excel sheets. Without guessing, a lot of the work next year will center on pruning costs given the dire economic outlook. A lot of companies have built up large capacities (plants, service centres) in the last fiscal with the growth mantra might just find the reverse happening next year. So can companies cut their fixed costs, maybe not but variable costs like payroll is very much on the cards.

Cutting jobs is perhaps the toughest choice a company makes especially when the mantra in the near past was "employees are our most valuable assets"- ask Naresh Goyal

With over 150,000 jobs lost in the month of October alone in the US (source ADP survey), the HR's axe has fallen rather quickly. Well these are a SUBSTANCE OVER FORM pointers towards ensuring the axe does not fall on you.

• If your boss was one of those "i saw Karzzz this friday" when you were working your donkey ass off reporting ...grrrnt.. and you just cant stand him..ugggh. get into discussing tandoori nights and urmila and Himesh's next movie for the short term... the better your relationship with him, the less likely you are to be cut.
• Do not post your resumes on job portals, your HR might just have access to these portals and will just about know who to cut basis the resumes on these portals. HR's like to keep the loyal kin intact. Its a catch 22 aint it, while you want to keep an eye on the job market. Well this is what you can do, look for portals which respect your privacy,displays your profile without your name or your present employment status to recruiters.... try http://www.shine.com/ for instance .. even monster is decent provided you have switched off the visibilty tag.
• Boss, cant you grant me some ESOPS?? will pay right down in cash at 20% premium on future cash flow valuations........gulp...... i beleive in this company's future (your boss might think you are big time crazy, but a lil loss on stocks (as though Dalal street hasnt made you a lot poorer) might just be the best ROI you have ever made in your life.
• Be the light box, don't be in a constant state of bad mood highlighting how vulnerable everyones' position in the Company is, try and be like Kareena's first half role from Jab We Met; bubbly
• Be visible on the floor, talk to everyone, a sweet hellozz to other functions, but most importanty, socialise with your HR breed....ahem... when was the last time you met this breed....increment letter....hmmm or when ,arre yar HR mein ek good looking ladki aayi hai
• Learn to use your calendar better, go for all those voluntary and involuntary meetings and be punctual on time... dont sit right in the front or the back .. stay in the middle. 
• Prove your value to the firm, Companies will not like to eliminate people if their customers find out that your contribution is indispensable; CUSTOMER IS KING.
• Give realistic insights & solutions- when your boss is drawing up a restructuring plan;
• Be open to change, even if it means you have to hotelise your cubicle with others - a little less trading on the stock portals - worth the effort;
• Start using NRI words to your colleagues like HEY CHIEF, HEY BIG MAN, WHATS UP DUDE -will make you sound BIG.... and VISIBLE.... and ......recessioned proof;
• Summary , just become the CORPORATE VISIBLE CITIZEN.
• Better read all blogs you can find on this subject... will keep you morally fighting for an another day

Its time to suck up now before you become the FP&A's number on that excel sheet....