Howe To Do It

Here are two articles taken from recent editions of Gulf News:

How To Do It: Accountants have let the investment community down

14-10-2002
 

Hands up if you thought that all accountants were boring, bland and blase. Now that some of the dust has settled, the finger of blame for most of today's economic woes can be well and truly pointed in their direction.

Whether they were poorly qualified, incompetent, corrupt or just plain greedy is academic. The truth of the matter is that they have let the investment community down by their inept behaviour.

How can such a mundane group of characters bring the financial world to its knees? Easy - they have not done their jobs properly. So just how do they "cook the books"? There are many ways in which the wool can be pulled over the eyes of an unsuspecting public.

In the good old days, if there was any fraud to be found it would normally involve the company accountant. Whether it entailed claiming non-existent expenses, using company's assets for personal use or introducing fictitious debtors or ghost employees, the modus operandi was simple and more common than one would have imagined.

There would be avenues for the incumbent to feather his nest but the overriding feature was that he was defrauding the company for his own personal use.

They would inevitably be found out. Some would be unlucky and get caught out by chance. Others would just get too greedy and too confident and unable to resist the urge to show off their newfound wealth. The moral of the story must be to get out whilst the going is good and keep your ill-gained wealth to yourself.

If they did get away with their deceit, it would only be a matter of time before the auditor snared them.

Students of history will recall Catherine the Great. Whenever she visited a town, all she saw was a facade, which, on first sight, gave the impression that the town was clean and tidy. If she had ever got out of her carriage to look behind the facade she would have found a different picture, that of dirt and grime.

Centuries later, some accountants are doing exactly the same by inflating sales figures or reducing expenditure. All looks well but if one were to investigate further, reality would indicate an accounting mess.

Two of the common methods are to reduce expenditure and increase revenue.

One innovative way that a certain U.S. company used was to capitalise most of its operating expenditure.

Corporate expenditure can be split into either operating or capital. The former is the normal spending with regard to the day-to-day running of the company whilst the latter refers to expenditure on fixed assets; these assets are written off as an operating expense over a certain period of time. For example an asset bought for Dh100,000 with an expected life of five years could be depreciated at Dh20,000 per annum using the straight-line method.

Profit is derived by deducting operating expenses from turnover. What these accounting clowns were doing was capitalising most of the operating expenses and writing them off over a period of time rather then expensing them all in the year they were incurred.

The end result is that the year's costs were greatly reduced and thus the profit was fraudulently inflated. The investing public seeing that their returns were higher bought into the company and share prices escalated.

The other way to increase profit is by upping turnover returns. This can be done several ways, but two to watch for involve large orders booked towards the end of the financial year and then reversed soon into the new year and non-existent sales to dummy offshore companies.

However, a diligent auditor would normally discover both of these wrongs.

In far too many recent cases audits have been unreliable and what has happened indicates that some audit firms have not been doing their job properly. In fact their job is to keep the management honest but the opposite has occurred in numerous high-profile cases.

Take the Australian auditor in that country's largest corporate failure. In June 2000, it was reported that HIH Insurance was operating with a $470 million surplus but by March 15, 2001, the company collapsed and with it billions of dollars of shareholders' and creditors' monies, not to mention the impact felt by other sectors such as builders, consumers, pension funds, etc.

In this case, the general integrity of the audit process was called into question and some felt that the auditors may have involved themselves in verifying accounts knowing them to be false.

Also muddying the murky waters was the fact that three of the company's directors were partners or former partners of the audit firm, one of whom signed off the accounts in October 2000.

No wonder that investors the world over are fleeing the equity markets when books of a company tend to reflect fantasy rather than reality. Although the Iraq crisis is one of many factors that impinge on the current economic woes, the main reason why stock markets have been falling is because of corporate juggling by the likes of Xerox, Tyco and WorldCom.

One can only look in disbelief and ask how a company such as Qwest Communications International Inc could have over-recorded $12.4 billion of revenue over the past three years.

There are some experts who feel that U.S. accounting scams might write off at least 25 per cent of earnings from the S&P 500. Others suggest the Nasdaq 100 earnings could have been overstated by $100 billion.

Furthermore there are estimates that off-balance sheet debt is a third of on-balance sheet debt in the U.S.

Because of cosmetic, and fraudulent, accounting practices, there is the distinct possibility of many shares being overvalued and that the real time bomb has yet to explode.

One obvious result is that huge amounts of funds have been leaving the equity markets and diverted into the property sector in many areas of the world. This in itself may cause a property bubble which, when burst, will result in another major economic downturn.

In August, the U.S. President signed a bill to fight corporate fraud under which American accountants will face a difficult future. They will have a strict new supervisor, they will be stopped from providing many ancillary services to their clients which in the past had proved to be a veritable money-spinner and their foreign arms will be subject to U.S. rules and regulations for the first time.

The accounting profession has a lot to answer for. When you next see your accountant, remember he might well be part of the accounting fraternity responsible for the present malaise in global capital markets.

How To Do It: Investors still prefer realty market

23-12-2002
 

It will come as no surprise to any Gulf-based investor to be told that the housing boom in many areas of the world has now run its course.

Few experts would disagree with the view that 2003 will see a softening in this sector and that any gains will be relatively modest especially when compared to the boom of the past few years.

There is also no doubt that many worldwide residential units are now overpriced. Reports out of London, for example, are predicting falls of as much as 30 per cent in certain areas of the capital.

Obviously in this type of scenario, it will take punters much longer to recoup their initial investment and the situation will be further exacerbated if there has been too much short-term supply. Then there is the distinct possibility of sale prices being substantially lower than the original purchase price in the short term.

Figures from Australia indicate how strong this investment sector has been as compared to other segments. For the year ended June 30, 2002, market returns have been:

- Australian shares - 4.7 per cent
- International shares unhedged -23.5 per cent
- International shares hedged -18.7 per cent
- Listed property +14.9 per cent
- Australian bonds +6.2 per cent
- International bonds hedged ; +7.7 per cent
- Australian cash +4.7 per cent

An almost 38 per cent range between international shares and listed property illustrates how robust returns have been investing in real estate.

Similar trends could well be extrapolated from other countries. Even if the heat has been turned off, investors might still prefer to put their money into bricks and mortar rather than say the volatile and ever-weakening global equity markets. That being the case, commercial property could be the next profitable return for the canny investor.

Generally the commercial property segment can be divided into three distinct sectors - industrial, office and retail property. The advice to the novice would be to diversify and invest in all three so spreading the risk (which will then reduce the possible return). The only way that this can be done is by the use of property funds and punters should understand what is on offer.

Industrial property will normally encompass land on the outskirts of town where the site value is comparatively low but returns can be correspondingly higher.

This is in stark contrast to office buildings which tend to be expensive to buy and can be technologically out of date quite quickly. The upside of possible speedy capital appreciation will be offset by its sensitivity to economic change.

The highest yields of all will be found in the retail sector. But again any downturn in consumer spending will lead to a softening in this sector as the retail demand sags.

There will not be too many who can afford to possess their own commercial property - consequently the entrée into this market is normally through property funds where the investors' contributions are pooled.

One major plus to the investor is that trading (buying and selling) in this area is much easier than trying to invest in just one building.

Added advantages are that they are more liquid and usually provide a secure income stream - assuming of course that the right investment has been selected and then has been professionally managed.

Do not be taken in by the slick real estate marketeers in whatever guise.

There are agents and brokers, the world over, whose jobs depend on them making sales who would have you believe that the property market will continue to boom. Both history and logic tells us otherwise.