Tapescripts unit 6

LISTENING

Costs in their proper place

The peanut butter approach to accounting is not a technique widely familiar to the UK's financial executives. And yet, according to Professor Robert Kaplan of Harvard University, if businesses do not become aware of the dangers of this strangely named type of accounting, they risk making the wrong decisions and losing out to the competition.

Kaplan is the co-author of a seminal work on management accountancy. Unlike most tracts on this subject, Kaplan's book, Relevance Lost, is surprisingly readable and makes a compelling case that conventional accounting techniques are ill-equipped to deal with modern manufacturing.

Kaplan pointed out, both in the book and in many articles before and after its 1987 publication, that the modern factory environment was different from its equivalent only a decade ago. Automation had replaced labour in the move to so-called world-class manufacturing, CAD-CAM and* just-in-time production. But the way of accounting for a manufacturing business had not moved on in a century.

Thus managers made important decisions about pricing and product mix with reference to figures which bore no resemblance to the true economics of making a batch of widgets or a custom-built motor. Costs were apportioned to the products on the traditional basis of labour hours – an inappropriate approach given the automated environment and, Kaplan argued, equivalent to a random spreading of costs across the portfolio of products – the peanut-butter approach.

In the last chapter of his book, Kaplan and his co-author offered some solutions. Managers should pay more attention to non-financial criteria when making their decisions, they argued. And they should scrutinise the precise make-up of the costs involved in opting to manufacture one product rather than another, abandoning the traditional accountant's distinctions between fixed costs and variable costs, between direct and indirect costs.

Kaplan was one of the early exponents of so-called activity-based costing (ABC). Under this approach, managers strive to spot 'cost-drivers', so i.e. the factors influencing the costs of the product.

The philosophy of ABC proved alluring, especially to the consultancy firms alert to a good marketing opportunity. But although most of the big accountancy firms have in recent years taken on squads of ABC consultants, it has always been very difficult to tease out any example of ABC being used in practice. The argument against identifying clients is usually that they are doing so well out of ABC that competitors should not be allowed to find out.

UNIT 7

LISTENING

Time to clarify the obligations of auditors

The 1990s pose fundamental problems for UK accounting firms. In addition to increased commercial pressures, the profession faces a threat from public policy makers. There is increasing suspicion about the effectiveness of self-regulation. Who audits the auditor? And who should do so?

The root of the regulatory debate is the auditor's position between, on one hand, the managers of public companies, and, on the other, their owners and other groups such as employees, pension fund beneficiaries, creditors and government departments which rely on the accuracy of the audited accounts. The auditor is hired by the managers to protect the interests of this latter group of 'stakeholders'.

There are obvious tensions when the interests of the two groups diverge – perhaps because of suspected fraud or more typically because managers have an interest in the reported results being well received by investors and others. Economists analyse such divergences of interest between one party and the agent employed to work on its behalf as a 'principal/agent' problem.

Traditional solutions of professional self-regulation backed up by legal redress as a last resort appear to be ripe for reform. Recent financial scandals have cast doubts on whether the threat of public disgrace is sufficient to safeguard audit standards.

These doubts are confirmed by the experiences of investors who have sought redress for auditor malpractice in the courts. Almost all such cases are settled out of court without any clarification of the legal duties. The Caparo case, which clarified auditors' responsibilities, underlines the gulf between what users expect, and what the auditor is prepared to offer.

The auditor's signature is treated by users of company accounts as an assurance of the quality of the information they contain – a kind of insurance policy against the risk that the company's true financial state is not what it appears.

The leading audit firms, whose strong brand names command a substantial price premium, have an interest in sustaining this belief. Yet attempts to make a claim on this policy show that pay-out terms are unreliable and highly uncertain.

The most common form of audit regulation proposed is to prevent auditors carrying out consultancy assignments for their audit clients – a feature of several EC markets. The Nera study showed that the major accounting firms rely heavily on audit clients for their non-audit business. But it also found the firms had managed to avoid the regulations in these countries.

A second mechanism, favoured in Italy and Spain and suggested elsewhere, is to have periodic compulsory rotation of auditors, to prevent too cosy a relationship between the audit partner and the management of the firm. But this causes potentially high disruption costs and raises questions as to the quality of the audit scrutiny during the transition period.

A third solution, favoured by some accounting firms, is to introduce measures to reduce the intensity of competition for the audit contract, removing the temptation to reduce audit quality as a means of cutting costs.

Protection from competition might reduce the tendency of the client to question the value for money offered by the auditor. But the idea that protectionism guarantees higher standards holds no more water in this context than elsewhere.

None of the models for reform suggested by the other EC states really addresses the principal/agent problem which underlies the need for reform. If the question of auditor independence is to be tackled, more fundamental issues need to be addressed.

UNIT 8

LISTENING

An important tax bill pending in the US Congress would permit depreciation of intangibles, including goodwill, for tax purposes. This would appear to eliminate a major US tax barrier against takeovers.

Just a short time ago, Congress had been carefully scrutinising possible tax incentives for acquisitions, such as deductions for interest expense, with an eye towards removing them.

Now it is considering a proposal that appears to increase the tax attractiveness of acquisitions, especially those in which large premiums are paid.

In July last year, Congressman Dan Rostenkowski introduced a bill, HR 3035 entitled 'Amortisation of Goodwill and Certain other Intangibles'.

The bill would provide a uniform 14 year amortisation period for goodwill and other intangibles.

The inability to deduct or amortise amounts paid for goodwill has long been one of the main constraints in tax planning of acquisitions in the US.

While businessmen recognise that goodwill may be an important business asset, they also recognise that its value may be fleeting. During the 1980s, the large premiums paid in acquisitions often resulted in prices that greatly exceeded the value of tangible assets, further increasing the significance of the non-deductibility of goodwill.

By allowing amortisation of goodwill, HR 3035 would appear to increase the attractiveness of acquisitions.

A closer examination of the proposal, however, reveals that the motive behind it is not to provide a tax incentive for acquisitions.

During the 1980s, as the premiums paid in acquisitions increased so did the incentives for creativity by tax advisers. Acquirers did not accept fatalistically that the large premiums they paid had to be additional goodwill.

Instead, the assets of targets were closely scrutinised to ensure that no possible depreciable or amortisable asset was overlooked.

Along with patents, licences, favourable contracts, the deductible assets uncovered included such items as:

• workforce in place (experience and composition of existing workforce);

• information base (business records, as operating systems, etc);

• customer-based intangibles (market share and composition);

• and supplier-based intangibles (any expected special value in the future from the acquisition of goods and services).

In many instances, the result was that the amount of the purchase price remaining to be allocated to goodwill was quite small.

However, the Internal Revenue Service challenged many of these claimed deductions.

Disputes between the Internal Revenue Service and taxpayers so involving very large sums of money ensued over whether these intangibles existed, the appropriate period for their amortisation, and the portion of the total purchase price that could be allocated to them.

These problems are the driving force behind the proposed legislation.

The uniform amortisation period for intangibles is intended to eliminate disputes over the existence, value and life of intangible assets.

The bill is designed to be neutral with regard to tax revenue although savings are anticipated from the reduction in complex disputes. Hence, the amortisation of goodwill is expected to be financed by increasing the amortisation period for some intangible assets.

For example, acquired computer software would be amortised over 14 years rather than the current five years and covenants not to compete would be amortised over 14 years rather than their likely much shorter lives.

Generally, the benefits (or detriments) of this new legislation would depend on whether an acquirer bought assets rather than stock. Business considerations may limit an acquirer's ability to choose.

For example, an acquirer may strongly prefer to buy assets because of concerns about large, difficult-to-measure liabilities of the business being acquired.

On the other hand, an acquirer who must make a hostile tender offer can only buy stock.

UNIT 9

LISTENING I

(I = Interviewer; CB = Claire Bebbington)

Part 1

I Why should companies be ethical or what are the advantages of a company in behaving ethically?

CB Mmm, I think the whole issue of ethics is a very complex one. Companies are made up of people. Multinationals are made up of many different nationalities. I think that companies are part of society and as such they should reflect society’s standards. Companies, especially multinational ones, do have responsibilities in the world and should try to be a positive influence and I think if a company is not ethical, then it will not survive as a company.

I Should a company have a code of ethics?

CB I think from my point of view it’s on two accounts. Firstly, it makes a commitment to certain good behaviour and so it’s a way of communicating the importance of good behaviour to all of its employees and partners. Secondly, if a company has a code of ethics and spends time communicating it, it does actually contribute to its ethical behaviour. If you express these things in writing, especially, then you will be held accountable for them. This tends to mean that you are much more likely to act on them as well. I think following up that code is difficult. People tend to have different ethical standards, and defining the term ‘ethics’, I can think, be a problem. But I think generally to express what your ethics are is a positive thing to do.

Part 2

I What kinds of moral dilemmas do large companies face? Can you think of any examples?

CB I think if you were to look at any company’s ethical code you would usually find in it a section about offering bribes and this can be an area where I think people can get themselves into hot water. Facilitation payments are part of doing business in many countries, and bribes are something which moist companies are not going to want to get involved in. But when does a facilitation payment become a bribe? And that is a question that can be quite difficult to answer.

I Can you think of an example where a facilitation payment is clearly a facilitation payment and not a bribe?

CB I think that there are many examples. When you are paying consultants to make introductions to new business contacts, obviously the reason you choose these consultants is because they are well placed to give that kind of advice in a particular country. And you’re paying for that introduction.

I Can you give an example of a facilitation which is closer to a bribe?

CB I would say size is important. Sometimes facilitation payments are out of proportion to the kind of business that you are expecting to win. I think there are many instances. Also, you have to be careful with issues such as nepotism.

LISTENING II

Economic Crime

It’s obvious what’s going on here in the middle of the night – a burglar is leaving the scene of his crime.

If we talk about crime we think first and foremost of burglars, thieves, murderers, forgers or perhaps smugglers. Crime is a problem because there are so many criminals. Today it seems there’s nothing problematic about this kind of crime, not for the police, or for the law court, because it’s quite obviously crime.

Here things are different. This man is also a criminal but at first sight, at any rate, nobody would think so – that’s because he lives and works like a successful businessman.

Unlike with burglars and thieves, here it’s quite a problem to recognize that this man earns his living in criminal fashion. But the fact is how difficult it is to catch him and that’s a special thing about economic crimes. The methods involved are mysterious and the people involved seem at first sight to be respectable citizens but the damage they cause other citizens, the state, and the country’s economy is often enormous.

He is still a beginner in the field of economic criminals – in the newspaper advertisement he promises that anyone selling goods for him – fine products at favourable prices – can get rich quick. The goods have to be paid for to him in advance by check or bank transfer. Lots of people blinded by the prospect of earning send him money. Perhaps if they are lucky they may get some goods in exchange but these will be worthless things that just can’t be sold, like this hair growth liquid. Quite frequently they won’t get anything at all for their money.

This trickster earns quite a lot of money even if it’s just a small-time crook Small-time crooks cheat little people who often don’t have much money. By the time these people realize what sort of trick they have fallen for it’s normally too late – the swindler has long since moved elsewhere and is now cheating other people.

The man here is a professional in the field of economic crime and he’s prepared very professionally for his latest crime. He’s already bought small quantities of meat here at the slaughter house on four different occasions. And he’s always paid punctually as soon as he got the meat. So by now he already has a reputation of an honest merchant and everyone trusts him. Today he orders huge quantities of meat. His customers he’s already selected in advance. Restaurants he approached are very keen to accept his offer because his meat only costs half the normal price. The local butchers also didn’t ask how come? or where from? when they offered him meat on very favourable terms. They ordered from him and some even paid him in advance.

Today is the agreed delivery day. The people from the slaughter house load the new customer’s truck – a customer who seems very respectable indeed. When it comes to payment the white-collar criminal tells the people from the slaughter house that this time they will get the money as soon as he’s delivered the meat to his customers. Since up to now he’s always paid punctually, the slaughter house staff trust him. But this time he doesn’t pay, he disappears with the money and the meat – probably heading elsewhere to cheat other people with similar tricks.

The people at the slaughter house only realize that they’ve been cheated when the money for their meat doesn’t arrive. Then they’re in a bad way – they have no more capital to buy cattle to slaughter, they have to dismiss most of their workers or perhaps even close down the slaughter house. These are the consequences of economic crime – white-collar crime, fraud.

Often it is the state which is cheated and that means all tax-payers, all citizens. Here, for example, a couple are having a house built. They paid the agreed costs including the wages for the building workers and all the taxes. But the owner of the construction firm is a criminal – he doesn’t pass on the taxes to the state he’s obliged to and keeps everything for himself – not just the taxes but also all insurance contributions. And when the matter finally comes to light he’s probably long since disappeared with his ill-gotten gains.

In the long term economic crime of this sort can undermine business morality. The butcher here accepts supplies of meat secretly at night simply because it’s cheap, he doesn’t ask where it comes from. The following day the customers are queuing in front of his shop because the meat here is so cheap. As competitor is more expensive so he doesn’t do any business that day. So he’s faced with two alternatives – either he closes the shop down or in future he also buys cheap meat from dubious secret sources. In this way economic crime can force otherwise honest people to join in as they don’t want to see their lives to be destroyed. When that begins to happen economic crime starts spreading fast like cancer. And economic crime can do more damage than all burglars, thieves and robbers together.

And that’s why the state and all its citizens have to protect themselves against economic crime and white-collar criminals and make sure that such people end up where they belong – behind bars.