What accounting rules and pigs have in common

More often than not, this column has been at pains to point out how companies have perhaps been a little liberal in their interpretation of accounting rules or at least have taken steps to put the best possible gloss on their performance.  So it may come as a surprise to find that today’s offering takes the form of a rant about some of the recent acts of lunacy perpetrated by the rule-makers. 


It all seems to have started with a relatively mild innovation, namely that companies should recognise profit on substantially completed work in progress and then keep their fingers crossed that the clients don’t challenge the bill or demand extra work to be done within the agreed fee.    At the very least it would have been prudent to require some sort of provision to be set aside for such unwelcome eventualities, based on past experience perhaps. 


Then we witnessed a more extreme form of lunacy when Huntsworth was expected to write off the goodwill element in the cost of companies it had previously acquired solely because it had decided to merge several such companies into one unit that continued to carry on all the activities previously conducted by the combining entities.   As a consequence profits for 2009 were dented by over £9 million.  Yet to this day it remains unclear how the value of those acquisitions was diminished by over £9 million solely by a decision to amalgamate them, unless of course the potential revenue earning capacity of the merged grouping had been diminished by that action – something that Huntsworth would vigorously deny. 


Last week we were reminded of another eccentricity when M&C Saatchi was obliged to treat a subsidiary, in which the vendors had retained a minority shareholding that they could require M&C Saatchi to buy later, as if it had bought the lot at the outset.  Not only does that allow 100% of the subsidiary’s profits to be treated as earned by the acquiring group from the outset (good news presumably) and for the estimated cost of acquiring the outstanding shares to be treated as a cost already incurred, but – and here’s the lunacy – any future revision of the estimated value of those shares must be included in calculating the acquiring company’s profit for the year in which the revision occurs.   So M&C Saatchi’s results are being dramatically distorted by big charges – or credits – in annual profits that reflect nothing else but an adjustment to the eventual likely cost of acquiring the subsidiary.  


In its latest accounts M&C Saatchi’s profits were reduced by £4.9 million, mainly because the value of the outstanding minority shareholding was geared to the exchange of a predetermined number of M&C Saatchi shares – shares that had been rising in value but just as easily could be liable to a fall.  In 2006 profits were reduced by £9 million, and in 2007 the profits received a welcome credit of £3 million when the estimated future value of the minority holding declined.  It’s as likely that this wildly fluctuating impact on profits reflects a fair view of the company’s performance as pigs may be flying over the offices of the international accounting standards board. 


It would make more sense if any adjustment to profits reflected only the notional cost of interest of the deferred purchase price, although even then the treatment makes no allowance for the legal possibility, albeit unlikely, that neither the vendors nor the purchaser may eventually elect to complete the transfer of the outstanding shares.  Any other adjustment to the eventual cost would be more appropriately reflected in the acquisition cost of the company concerned. 


Is it not time that the IPA’s finance policy group set about making some formal representations to the accounting rule-makers, not least because the investment community is already making a mockery of the rules by recalculating reported profits to ignore their effect.   It’s time this “as if” accounting stopped and we found our way back to the real world. 


Bob Willott is editor of “Marketing Services Financial Intelligence” at www.fintellect.com.

  • Alex Hunter

    Thanks, Bob. I fear it won’t be the last time that strict interpretation of Rules seem to be contrary to Common Sense – or “True & Fair” as we used take as the ultimate test. The IPA’s Finance Policy Group will certainly look at the underlying issues with a view to making whatever representation is most appropriate. I appreciate the pointer!