The Accountant March-April 2016

MANAGEMENT
BUSINESS PRACTICE AND DEVELOPMENT
By Dominic Ooko, ooko@ca.go.ke
Photo: ACCA South Africa Blog
By Joseph Kariuki, Audit Partner
jkariuki@kpmg.co.ke
Photo: coindesk
Why your
strategy needs
an open mind
The basic rule for most
organizations nowadays is
to put a few top people in a
room to brainstorm or find
a solution to a problem or
develop a product. Usually, the tone has
been set at the top and it would take a lot
of courage to deliver a contrary verdict on
its viability. This approach tragically leads
to sloppiness in testing the feasibility of
the product or solution on its acceptance
and value to the customers. Generally, it’s
not easy to predict what’s most valuable
to customers in the future, but the cost of
groping in the dark maybe suicidal to the
organization. This lesson is learned from
Roald Amundsen’s book the Last Place on
Earth that chronicled his conquest of the
South Pole.
Twelve days before embarking on the
expedition, on Friday, September 8th,
1911, the Norwegians led by Amundsen
left Framheim heading south in pursuit of
the South Pole. By Monday, less than 40
miles out of the base camp on the Ross
Ice Shelf in Antarctica, the thermometer
sank to minus 60 degrees. The winds were
gusting up to 100 miles per hour and the
men had to build Inuit-style igloos to keep
out the storm. The next day, the liquid in
the compasses froze solid.
The men were completely exhausted,
and after 12 continuous hours of merciless
struggle against the cold and wind, all the
men arrived back safely to their base camp.
Five of the sledge dogs had died and most
of the men were blistered and frostbitten.
The next morning, most of the men agreed
that the whole idea of starting so early for
the Pole had been a mistake.
The retreat had exposed critical
weaknesses in their equipment and these
were subsequently corrected in readiness
for their actual conquest of the South
Pole 12 days later, delivering the ultimate
defeat of the British team by arriving 34
days earlier on December 14th, 1912. In
tragic contrast, the Amundsen expedition
team of 19 men all made it to South Pole
and returned safely to Norway, while
the British team led by Naval captain
Robert Falcon Scott lost 5 men out of a
team of 65 men including the expedition
leader himself! For no apparent reason,
the final British 5 man team arrived in
South Pole hauling 14kg of rock samples
for geological souvenirs but without food
rations for the long way back nearly
300 miles to the nearest food and fuel
station. They all perished. Had they had
equivalent weight of sea seals they would
have survived.
This experience from the Last Place
on Earth suggests that an entity should be
prepared to undertake thorough testing of
its product or solution and not be afraid
to quit a project albeit in the interim.
Richard Dawkin called it the Concorde
fallacy where the stakeholders perceive
the sunk cost as too expensive to abandon,
after the Concorde plane promoted by the
British and French governments despite
knowledge that it was not economically
viable.
An entity should readily undertake
a self-internal reflection on the viability
of a project and not be afraid to quit or
pause. It’s a fact that most times there’s no
sufficient evidence to deliver the contrary
view of quitting and indeed there’s no
magic bullet. The proposed solution is that
management needs to think differently,
a bit more, including considering a
temporary setback or retreat.
The Writer is a Finance Manager –
Communications Authority of Kenya
New lease accounting
standard brings added
transparency to the
balance sheet
The new lease accounting
standard published on
13 January 2016 by the
International Accounting
Standards Board (IASB) brings
added transparency to the balance sheet,
according to KPMG International.
The new standard requires companies
to bring most leases on-balance sheet,
recognising new assets and liabilities. At
present, many analysts adjust financial
statements to reflect lease transactions that
companies hold off-balance sheet.
Commenting on the new standard
following the release, Kimber Bascom,
KPMG’s global IFRS leasing standards
leader, said: “All companies that lease
major assets for use in their business will
see an increase in reported assets and
liabilities. This will affect a wide variety
of sectors, from airlines that lease aircraft
to retailers that lease stores. The larger the
lease portfolio, the greater the impact on
key reporting metrics.”
Companies are currently required to
disclose details of their off-balance sheet
leases and analysts use this information
to adjust published financial statements.
Bascom continued: “Current lease
accounting requires financial statement
users to adjust for off-balance-sheet leases.
The key change will be the increase in
transparency and comparability. For the
first time, analysts will be able to see a
company’s own assessment of its lease
liabilities, calculated using a prescribed
methodology that all companies reporting
under IFRS will be required to follow.”
The impacts are not limited to the
balance sheet. There are also changes in
accounting over the life of the lease. In
particular, companies will now recognise
a front-loaded pattern of expense for
most leases, even when they pay constant
annual rentals. And the new requirements
introduce a stark dividing line between
leases and service contracts – the former
will be brought on-balance sheet, while
service contracts will remain off-balance
sheet.
The new standard takes effect in
January 2019. Before that, companies will
need to gather significant additional data
about their leases, and make new estimates
and calculations that will need to be
updated periodically. Brian O’Donovan of
KPMG’s International Standards Group
commented: “The new requirements are
less complex and less costly to apply than
the IASB’s earlier proposals. However,
there will still be a compliance cost. For
some companies, a key challenge will be
gathering the required data. For others,
more judgemental issues will dominate –
for example, identifying which transactions
contain leases.”
The accounting changes do not affect
cash flows directly. However, given the scale
of the accounting change, KPMG expects
that companies will be keen to understand
the size of the lease liabilities arising from
transactions they enter into between now
and 2019. O’Donovan continued: “No one
wants to see accounting drive business
behaviours – the tail shouldn’t wag the dog.
But if accounting consequences are in the
mix when a company is considering a deal,
then the mix will change. For example,
this standard essentially kills sale-andleaseback
as an off-balance-sheet financing
proposition.”
Some key impacts cannot yet be
quantified. O’Donovan continued:
“Companies won’t have the full picture
until other accounting and regulatory
bodies have responded. For example, the
new accounting could prompt changes
in the tax treatment of leases. And a key
question for the financial sector is how the
prudential regulators will treat the new
assets and liabilities for regulatory capital
purposes.”
The US Financial Accounting
Standards Board (the FASB) will publish
a new US GAAP standard on lease
accounting shortly. Although the IASB
and FASB worked together on lease
accounting for years, their final standards
feature different lessee accounting
models. Bascom concluded: “It’s ironic
that the outcome of this long- running
convergence project will be divergence
in accounting for common lease types.
The new IFRS and US GAAP standards
will introduce differences in the profile
and presentation of annual lease expense
where none currently exist, reducing
comparability between the two major
accounting frameworks.”
About KPMG East Africa
Our East Africa practice comprises of
Kenya, Uganda, Tanzania and Rwanda.
KPMG East Africa has 21 partners
and over 1000 professional staff. The
Nairobi office serves as the regional
coordinating office providing the
required networking and support
to facilitate delivery of services on
a timely basis to meet and exceed
our clients’ expectations. KPMG East
Africa provides services in Eastern
Democratic Republic of Congo, South
Sudan, Burundi, Somalia as well as
Ethiopia
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