X-Message-Number: 19393
From: "Stephen Bogner" <>
Subject: Re: Note on Investment and Accountancy Collapse
Date: Tue, 2 Jul 2002 14:02:55 -0600

John de Rivaz writes:

"This is an accountancy issue. /stuff deleted/ To my mind, the costs have
been allowed for, allbeit in the wrong columns, so surely the end result is
the same."

Although I am an Engineer, and not an Accountant, I would like to offer the
following from my own experience managing financial issues for several
companies.

I spent a lot of money on Accountants in the past on the assumption that as
full fledged professionals they would have knowledge and expertise that I
could not duplicate economically on my own.  I further assumed that using
these professionals was good business because they would more than pay for
themselves by finding tax saving opportunities for me and by keeping me in
compliance with all the appropriate rules and regulations.  I could not have
been more wrong.

The first thing that I learned was that most "accountants" are simple
overpaid data entry clerks.  The more advanced accountancy functions are
performed by more sophisticated data entry clerks using more sophisticated
software.  All of the logistics and mechanics of accountancy are readily
executed in software.  The software is very good, and very inexpensive.
Anyone with a high school education can easily learn to use it - and should.
If you are running a business you will be collecting and entering all of the
necessary data on a more or less continuous basis.  (If the SEC wanted to,
it could require all public companies to post real time current financial
information on a website in real time so that is was available to all
investors at a time that was useful.  Unlike now, where they only have to
report quarterly results a quarter after they are current.)   The difference
between accounting for a small business and a big business is simply
quantitative, and not qualitative.  If you understand how it works for a
small business then you understand how it works for a big business.  In my
experience, most accountants are drones that can be replaced by a couple
hundred dollars worth of software and a week or two with a good textbook.

The second thing that I learned was that you need to keep 3 sets of books.
The first set of books is the one where you track the value and performance
of your company the way it really is.  In this set of books you track assets
and liabilities at their actual current market value, and you track income
and expenses on a cash basis.  The second set of books is the one where you
track using GAAP (Generally Accepted Accounting Principles) - which believe
it or not vary depending upon which country you live in.  In this set of
books you track assets and liabilities at cost (regardless of real market
value) with depreciation based upon what GAAP allows you to claim -
regardless of whether or not it is "real" - and you track income and
expenses on an accrual basis.  The only purpose for this set of books is to
show bankers or investors in an acceptable format that they are comfortable
with - even though that comfort might be misplaced.  The reason they are
comfortable with this set of books is because it is very conservative, which
is favorable to lenders in particular - and not so favorable for the
business owners trying to negotiate with them.  The third set of books is
the one where you track using taxation rules - which are an even more
artificial construct than GAAP.  In this set of books you classify and track
assets and liabilities according to what is currently required or allowed by
the tax policy of the day - which can change arbitrarily at any given
government budget and is unlikely in any event to be closely coupled to
marketplace or financial reality in any event, and you classify and track
income and expenses on either a cash basis or an accrual basis or a bastard
version of both depending upon the history of your company and the
vicissitudes of government policy.

The third thing that I learned was that the only place where accountants can
occasionally exercise discretion is in deciding how and when to tie income
or expenses to assets or liabilities.  GAAP tries to dictate this process to
make it predictable (and conservative).  This is where the mischief gets
done, by the few accountants who are not drones.   These creative
accountants try to get around GAAP so that the "GAAP approved" set of books
that the company has to show investors (set of books #2) more accurately
reflects the way the accountant or CFO thinks that the company should really
look (set of books #1).  The way they do this is simple, and in my view says
more about problems with GAAP than problems with the accountants ethics.
The critical objective is to try to reflect the true current market value of
the assets owned by the company, when GAAP tries to say the most they can be
worth is what was paid for them originally.  The problem is that many or all
of the activities that the company undertakes to increase the value of the
asset (in the case of WorldCom this asset was apparently its fiber network)
are viewed by GAAP as "current expenses" which need to be written off in the
year in which they are incurred and do not add any value to the balance
sheet, when the reality is that they are actually "capital expenses" that
add value to the market value of the asset but that added value cannot be
shown on the balance sheet until the asset is actually sold and the value is
realized as a capital gain.  As a result, the expenses for these
improvements to the underlying asset show up as operating expenses, rather
than investment expenses, and the investor sees high expenses and low
profits, without any improvement in the net worth of the company (as
reflected on the Balance Sheet) to justify or tell him where the money went.
The result is that a good company that is maintaining or improving
productive assets that it already has on its books is penalized relative to
another company that buys new assets, at perhaps an inflated and unjustified
price, perhaps by taking over another company.  The acid test, at least for
me, is does the expense increase the true market value of the capital asset?
If the answer is yes, then it should be considered to be a capital expense
rather than a current expense, and that increase in value should be
reflected in the balance sheet and that expense should not be considered to
be a normal operating expense.  Apparently, the CFO of WorldCom also took
this viewpoint.  GAAP does not.  It would rather show a book value that is
much lower than the true current market value, and an operating deficit that
is higher than what is really happening in the company.

The flip side of this, and where I have most of my experience, is where a
company would like to reclassify a capital expense to a current expense so
that it can write off the expense in the current year to reduce profits (and
hence taxes).  This is usually only seen in profitable private companies,
and is aggressively discouraged by tax regulations.

It is a little tough to tie this thread back to cryonics.  But lets try
this:  Sometimes, things are not a bad as they seem, if you understand the
technical basis of game that is being played out.  If you understand and
have confidence in the technical fundamentals then you can sometimes avoid
being misled by the reactive psychology that plays out around an issue like
this.  A second point, is that the accepted dogma (i.e.. GAAP), can have
glaring and blatant holes that are highly prejudicial to the interests of a
major party that is affected by it, and still be the dominant and governing
meme for everyone involved, with or without their consent.

That said, I would not invest in WorldCom at this point because I think that
it is fatally wounded in the marketplace - which is clearly being driven by
psychology and not fundamentals at this point in time.  But I would consider
investing in the company that is going to pick up the very real and tangible
assets of WorldCom because these assets will likely be severely discounted,
even perhaps to a point below their already misleadingly low book value (or
perhaps not so misleadingly low if you use the numbers before restatement).

Steve.

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