27 July 2005

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Creative accounting

by Karm Farrugia

“Creative Accounting is for artists, not Investment Ministers. Period”

So much bad blood would probably have been avoided, especially at a time when the sale of a public asset ( Sea Malta ) had already been negotiated and was in fact in its final stages, if the Minister had been advised how to put it correctly and with dignity, however frustrated he must have felt. Not ‘monkey business’ or even ‘window dressing’. No board of directors deserves such appellations, only to be followed with the retention of all of them except the chairman. The new one had no time to look for creativity in the accounts for 2 years and explain the issue in suchlike terms. He had to sign what he did not agree with. That’s business life, I reckon.
Equally, dignity was wanting on the part of the resigning chairman. She, too, was frustrated at the utter downright refusal of her majority shareholder to invest in a new faster vessel: the only salvation act she, and presumably her co-directors, must have strongly believed in. However solid her case might have been, she could not possibly win the day against her political master who had already taken the decision to sell and was in fact busy negotiating terms.
An environment of quasi-megalomania at Sea Malta, which I experienced eight years ago, does not seem to have abated. When in late 1996 the new Minister responsible for the company offered me the chairmanship, he pointed out that it operated profitably and my task was to ensure that it continued to do so. His advisers had based their views on the 1995 accounts; none of them had bothered to search for any ‘creativity’ element when they showed a respectable overall profit - very much in the nature of the current controversy.
I did soon after when I took office early January 1997 and, as is my wont, I was more interested in management accounts than in published ones. I was shocked. The indications left no room for doubt: commercially speaking the company was a loss-maker and had been so even when the published accounts had registered a profit. The management was competent; so were the staff, though these could have had a dose of superfluity, an area I put down on my agenda for study. The clients were generally satisfied with the service they were receiving. But viability?
There was a sense of pride around in that company, which ,unlike all others in the public sector, had never asked for protection from competition even when this was government policy. The fact remained, however, that it was not operating profitably as the general public perceived it. Top of my agenda.
In a few months time I would have had to sign a set of dismal financial statements, unless, I was whispered in the ear, someone came up with yet another ‘creative’ idea to throw some light on an otherwise dark surface. I emphatically said ‘No’. On the contrary, we needed to clean up the accounts in accordance with old-established accounting principles which, inter alia, honoured conservatism in asset valuations, distinguishing between profits made (on revaluation) and profits realised (on their eventual sale or disposal). Whereas the latter should obviously access the Profit & Loss Account, the former should only feature in a note to the accounts or, possibly, bye-passing the P & L onto a Reserve for Revaluation of Assets Account.
As events turned out my co-directors (all new, bar one) considered my reform zeal as too radical and would upset executive management. My stay lasted less than 3 months. Ironically, I was labelled ‘reformist’ as an economist, but ‘conservative’ as an accountant. That explains why I had vehemently resisted the spread of ‘creative’ accounting when discussing the issue when at Malta Development Corporation years earlier - a number of manufacturing units were seeing the end of their ten-year tax holiday. Understandably, they wanted to know where they stood taxwise. Creative accounting working in reverse seemed to work. I never liked it.
Contray to what a Grimaldi director was reported to have said, there is nothing ‘illegal’ in appreciating an old asset ‘because such an act jeopardises the right of creditors’. Misleading, yes, and very much so if such creditors do not bother to carefully read and analyse published accounts in the same way as an insurance broker does for his clients.
The Enron and Parmalat scandals, dear Mr Grimaldi, were false and fraudulent, not creative ones. You are right, however, to be yourself misled because the difference is not always easy to discern. I would in fact go as far as to state that if the world accounting body had put its foot firmly down when creative accounting was spreading, especially with multinationals, instead of succumbing to its call for some sort of recognition, the international community might possibly have been spared some of the scandals.
International Accounting Standard 36 is a recent one. I regard it as defeatist. It is resorted to by shipbrokers, amongst others, to fall into the temptation to value non-property assets (like old ships) within the price range desired by the client but adding a proviso that such values can fluctuate furiously and widely and suddenly in the market. Twelve years ago I experienced this phenomenon when at Malta Shipbuilding: I was trying to assess the current market value of the Russian timber carriers when it seemed that the Russians were reluctant to take delivery. The values given by different brokers would have yo-yoed the accounts. And the ships were ‘new’ in usage, though not in age.
Perhaps someone in possession of Sea Malta’s financial statements would explain their ‘creative’ nature and put to rest this unpleasant belligerence.

The author is an economist

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