GAAP: A manmade science

Accountancy SA,  May 2003  by Hattingh, Charles

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I recently bought a projector to improve the presentation of my workshops. On opening the box I broke out into a cold sweat. Yes, the instruction book was included in the box but I was terrified to read it. I telephoned my computer expert for help. He arrived at my offices, opened the manual, said blue to blue, cord to plug, turn computer on and press on switch on top of projector. Miraculously, my computer screen appeared on the wall. Question: "Why was I not capable of reading the instructions?" Answer: "Because I am not trained to do so."

After a two-day workshop on GAAP for the clerks of one of the large auditing firms a candidate for part one of the qualifying examination said: "Thanks for showing me the source of GAAP." I asked her what she meant by this statement and she said that at university they were given the knowledge verbally but they were not told where it came from. Surely the objective of education is to equip students to fend for themselves in the big wide world of accounting?

If they are not trained to interpret statements of GAAP, what do they do after they are qualified when new statements are published? Go back to university to listen to the new statements?

From my dealings with accountants, I find that they seldom refer to the Statement when they have a problem. This is because they are not in the habit of doing so. When I run GAAP workshops I force participants to refer to the statement every time we address an issue.

During a tea break at one of my in-house GAAP workshops a manager told me that he asked his auditors whether or not one should account for the embedded call option of a convertible debenture separately to the debenture itself. His auditors said that they were unsure and would consult their overseas people. What intrigues me is why no one bothered to look at AC133 paragraph .24. From a reading of this paragraph, and the explanatory paragraphs that follow, it is crystal clear how such a derivative should be handled.

One of the large banks approached me to advise them on whether or not collection costs should be taken into account when calculating bad debts. The statement is not clear whether the net or gross cash flow should be used when discounting cash flows from debtors. I studied the statement from paragraph 1 to paragraph 174. There is no specific guidance on this matter but the spirit of the statement seems to imply that one does not take into account collection costs. I know from experience that listed furniture companies, for example, do not provide for these costs, probably on the basis that they have not yet been incurred. This is contrary to writing inventory down to NET realisable value and writing property, plant and equipment down to recoverable value AFTER deducting disposal costs and valuing biological assets AFTER point of sale costs. So I gave an opinion saying that they should not take collection costs into account. They wanted to do the right thing so they obtained opinions from three large auditing firms. Two said: "Don't" and one said: "Do". So I quoted my friend, philosopher and deep thinker on matters accounting, Deon Joubert from Eskom, who once told me "GAAP is a manmade science". I suggested that the bank write to the IASB, the source of GAAP and the people who make the science, to get a ruling on the matter. The reply received was: "We set standards. We do not interpret them. Get an opinion from your auditors." What chance do we have of achieving comparability in this environment?

Circular 7/2002 on headline earnings was issued in December 2002. Have you read it? In case you have not, here is a brief summary of the circular:

Headline earnings are a robust and factual measure of trading performance separated from profits and losses on capital items. It commences with net profit or loss per the income statement and eliminates all capital gains and losses. Its objective is to provide an unambiguous reference point between users, the press and the statistical companies. It eliminates judgement in the calculation of the amount. The thinking behind headline earnings is that assets are engaged to generate wealth from trading and not as an end in themselves. Headline earnings reflect the trading aspect of the operations.

The circular goes on to give rules as to what is in and what is out. It clearly states that if an asset is acquired for resale, any gain or loss is included in headline earnings. In AC133 terminology, these assets would be 'held for trading' financial assets. The circular states clearly that one should not confuse held for trading with available for sale financial assets. The latter would include strategic investments, unconsolidated subsidiaries, associates not equity accounted, etc. I got into a major tussle with three CAs on the interpretation of this circular regarding 'held for trading' and 'available for sale'. All three stated that a profit on the sale or revaluation of an available for sale financial instrument is included in headline earnings. After a serious debate with one of the three, I asked if he had read the statement and he said: "No!"