At the Mercy of Financial Statements

[Temperament]

Extract: BT.
"SINGAPORE - What if someone told you that the financial statements of a company that you depend on to make your decisions - as an investor, creditor, potential acquirer or some other stakeholder - were almost totally the result of human judgment rather than hard fact?

It would seem an unbelievable scenario to many. But the fact is, it is now very much the reality here.

In the first such study of its kind, KPMG has analysed 200 Singapore-listed companies - ranging from small caps to large caps, and including the likes of SingTel and SMRT - and found that 82 per cent of the asset values represented on their balance sheets are based on estimates and must be re-estimated when their balances are carried forward into the next financial year.

What this means is, a huge proportion of total asset values reflected in existing financial statements are at risk of being subjected to some form of human bias, error or mis-statement in their derivation.

That's not all. KPMG's report found that as little as a one per cent fluctuation in the total asset value can result in as much as a 38 per cent change in net profit - and up to a 50 per cent change in comprehensive income. The impact of inaccurate estimates of asset values is, therefore, significant.

These are assets that have to either be carried at fair value or are subject to impairment charges; common examples are intangible assets such as goodwill, and tangible assets such as investment property.

"Estimates are, by their very nature, subjective. They are underpinned by the nature and reliability of the information used to form these accounting estimates - which can vary widely," said Ong Pang Thye, head of audit at KPMG in Singapore, yesterday.

"Management bias can be a major problem in determining accounting estimates. It can be both unintentional (for example, human error) or intentional (for example, motivation to achieve a desired result). The susceptibility of an accounting estimate to management bias increases with the subjectivity involved in making it," Mr Ong added.----------"

IMO.
i always feel we are all at the mercy of the accuracy of ARs from anywhere in the world. Not necessary Singapore.
Amen.

[felixleong]

all the asset value all very subjective
example we can go take a look at suntec reit

they mark up their asset values sooo high
its now trading at a discount to nav wor, how can it be when almost all other reits are trading at a premium to nav?

[Herodot]

That's not all. KPMG's report found that as little as a one per cent fluctuation in the total asset value can result in as much as a 38 per cent change in net profit - and up to a 50 per cent change in comprehensive income. The impact of inaccurate estimates of asset values is, therefore, significant.

Imaginary net profit hit by imaginary downwrite of imaginary assets.
Thats why one should focus on cashflows.

[KopiKat]

all the asset value all very subjective
example we can go take a look at suntec reit

they mark up their asset values sooo high
its now trading at a discount to nav wor, how can it be when almost all other reits are trading at a premium to nav?

The concern is not so much on the NAV, but what happens from Operating Profit to PBT onwards...

That's not all. KPMG's report found that as little as a one per cent fluctuation in the total asset value can result in as much as a 38 per cent change in net profit - and up to a 50 per cent change in comprehensive income. The impact of inaccurate estimates of asset values is, therefore, significant.

These are assets that have to either be carried at fair value or are subject to impairment charges; common examples are intangible assets such as goodwill, and tangible assets such as investment property.

[NTL]

Which asset valuation is not an estimate? Especially so with properties. Just look at the property market, so much estimation there. Valuation for a unit which I enquired previously ranged from $800,000 to $1,000,000. That is a 25% difference!

So, it is always easier to evaluate financial statements that are basically made up mainly of "Revenue", "Cost of Sales", "Selling Expenses", "Financial Expenses" & "Tax". Not much of "Revaluation of Assets (or Biological Assets)", "Goodwill", "Negative Goodwill" or "Change in Inventory".

[Dividend Warrior]

That's not all. KPMG's report found that as little as a one per cent fluctuation in the total asset value can result in as much as a 38 per cent change in net profit - and up to a 50 per cent change in comprehensive income. The impact of inaccurate estimates of asset values is, therefore, significant.

Imaginary net profit hit by imaginary downwrite of imaginary assets.
Thats why one should focus on cashflows.

Enron!!!

[Temperament]

Cash Flow:

It's always believe that cash flow is quite difficult to monkeying around, but it can be done too. Cash Flow can be affected by manipulating working capital like inventory, cash receivables and accounts payable. It also can manipulated by reporting certain expenses as capitalised rather than expensed; like R & D expenses. Last but not least, one time tax benefit of some "extra-ordinary" sale or action.

Indeed investing is really no walk-in-park, feeding the pigeons.
And the worst thing is "pro- accounting analyst may not be able to spot the "hanky panky" until it becomes public news.
So can we better than them-the PRO?
Shalom.

[Ben]

Cash Flow:

It's always believe that cash flow is quite difficult to monkeying around, but it can be done too. Cash Flow can be affected by manipulating working capital like inventory, cash receivables and accounts payable. It also can manipulated by reporting certain expenses as capitalised rather than expensed; like R & D expenses. Last but not least, one time tax benefit of some "extra-ordinary" sale or action.

Indeed investing is really no walk-in-park, feeding the pigeons.
And the worst thing is "pro- accounting analyst may not be able to spot the "hanky panky" until it becomes public news.
So can we better than them-the PRO?
Shalom.

Agree. This is why it is so important to look at the financial statements over many quarters instead of just one or two quarters, presumably it is a lot more difficult to manipulating financial statements over longer periods. Also, there are criteria to be met before an expense can be capitalized, specifically so for R&D. And it has to be expensed off after certain time.

If the financial statements of a company are too difficult to understand, with many questionable items, then it is better to move on to the next one. End of the day, it is better to stay with those that you are comfortable with. Life will be much easier this way.

[specuvestor]

Financial statements are a shadow of reality. It is anyway a snapshot of the company at a specific day. Agree with Ben that over the course of history one would understand the business model TRANSLATING into numbers, and the credibility/ capability of management much better than the numbers per se. Though i agree with Temperament, but of the 3 cashflow statement is the most instructive.

The scary part is that people think the numbers are reality, when they are no more reality as a photo or a shadow. Even as a tech and a "scientific" guy it is ironic to me that people trust so much on numbers and tech than humanity or common sense. Disasters happen, from algo trading to the Korean air crash at San Francisco, when people lose their sense of reality.

[GPD]

Financial statements is hard fact + human judgment and not human judgment rather than hard fact. In essential, we are playing with both potentials and possibilities but it is not different from most other things. For example, when we want to take out say a 30-year housing loan with a bank, they evaluates our existing financial health (hard fact) and potential to repay the loan over the next 30 years and possibilities of default (human judgement).