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Major accounting misconduct was
unearthed by US company Caterpillar
Inc. in a Chinese business it purchased
in 2012. Irregularities included
overstated profits and falsified stocks.
sheet and may encourage it to
expand beyond its means. All it
takes is a fall in the stock market for
this valuable shareholding to
become worth considerably less.
Myddelton suggests that it is better
to use “historic cost” accounting
than “mark to market,” since this
provides a more stable set of figures;
it values assets at their cost at time
of purchase, minus any depreciation
that has taken place, rather than at
their current market value.
The argument of rigid rules
vs. looser-based principles will be
heard repeatedly when the merger
talks between the US’s rules-based
GAAP system and the IFRS
become serious. Even though the
IFRS is far more rule-based than
its predecessors, it retains a greater
reliance on principles than the
US’s GAAP system.
Ethical conduct
Whether rules based or rooted in
principles, no accounting methods
can prevent a deliberate attempt
by directors to mislead. In June
2012, for example, US construction-
equipment giant Caterpillar Inc.
completed a $650-million purchase
of Chinese company ERA Mining
Machinery Ltd. and its wholly
owned subsidiary Zhengzhou
Siwei Mechanical and Electrical
Equipment Manufacturing Co.
This was part of Caterpillar’s
long-standing strategy of growth
in China. Unfortunately, a series of
black holes in Siwei’s accounts
soon emerged, including the
discovery in November 2012 that
the company did not hold the stock
levels it had claimed. In January
2013 Caterpillar said it was writing
off $580 million from the value of
ERA, thereby virtually admitting
that the purchase was a complete
waste of money. Caterpillar then
accused the previous management
at Siwei of deliberately creating
misleading accounts, but let the
matter drop in May 2013 when a
financial settlement was reached.
In other circumstances, directors
can find solace in the rules.
Operating in South Africa, Canada,
and Europe, short-term money-
lender Wonga.com sets its annual
percentage rate (APR) on “payday
loans” as high as 5,800 percent.
This is perfectly legal because theMAKING MONEY WORK
countries in which it operates have
no legislated cap on interest rates,
so the directors are playing by the
rules. However, a report by the UK
Citizens’ Advice Bureau in 2013
stated that three out of four “payday
loan” customers struggle to repay.
In contrast to the UK, countries
such as France and the US have
rules that set maximum interest
levels for consumer credit loans.
Ultimately, no set of rules can
substitute for ethical behavior
nor safeguard the system from a
determined attempt to manipulate
accounting figures in a misleading
way. In the hands of principled
accountants, flexibility within the
rules is useful; but if someone seeks
to gain huge financial advantage
no matter what, that flexibility will
enable him or her to do so, even
if this entails acting immorally.
Rules help to ensure that
companies operate at an acceptable
minimum standard. The argument
revolves around where this standard
lies, balanced as it is between useful
standards and costly overregulation.
Rules also encourage those with
ethical principles to go further
than the minimum. ■Mark-to-market accounting
is like crack. Don’t do it.
Andrew Fastow
US former Enron executive (1961–)