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Thursday, June 30, 2011

Cost Audit Rules 2011-finally recognizes management accountants

For ages, Board of Directors dealt with atleast 3 auditors. The statutory auditor for accounts/tax, the internal auditor for improvements and the cost auditor for cost accountancy. Internally, there was this feeling that cost auditors are just the Government's spy, who do not give any value add to the company. Though the cost audit report did contain an optional space for cost auditor's to fill, the bulk of the report entailed verifying numbers/ratios from management accounts, mainly for purposes of tariffs, taxes and subsidies. Otherwise, the report did not add value directly to the company, and expected it to analyze the numbers itself.

The Cost Audit Report Rules 2011(http://www.icwai.org/icwai/docs/Revised_Report_Rules_03jun11.pdf) framed in June-11, promise to bring a paradigm shift. The Cost auditor has to submit a performance appraisal report to the company's Board of Directors.The report format is reproduced below.

 Name of Company: __________________________ Period of Report: ______________ 
(indicative list of areas to be covered in the report)y(emphasis added) 
1.  Capacity Utilization Analysis  
2.  Productivity/Efficiency Analysis  
3.  Utilities/Energy Efficiency Analysis 
4.  Key-Costs & Contribution Analysis 
5.  Product/Service Profitability Analysis 
6.  Market/Customer Profitability Analysis 
7.  Working Capital & Inventory Management Analysis 
8.  Manpower Analysis 
9.  Impact of IFRS on the Cost Structure, Cash-Flows and Profitability(emphasis added)
10. Application of Management Accounting Tools(emphasis added)  

While any well managed company would be anyway doing most of this, the report serves as a second opinion. Also, given that IFRS will impact Indian companies from this fiscal(2011-12) onwards, Boards would be interested in knowing the effect of IFRS on their reported earnings etc. And then, a cost auditor with multiple clients is well equipped to comment on the application of management accounting tools.

Anyways, if the report is done by the auditor himself(instead of cut pasting internal audit reports), then respect for the profession will increase. And it would certainly be a value add, and intellectually challenging exercise.

Cost Accounting Rules 2011-the fine-print & sea change

When the Central Government notified The Companies (Cost Accounting Records) Rules, 2011(http://www.icwai.org/icwai/docs/Common_Record_Rules_03jun11.pdf) in June-11, cost accountants(or management accountants as they are better known) and their institute the ICWAI must cried with joy for the extra assignments which these rules entail. After all, more certifications/audits mean more business for professions. But the fine print brings out the devil in the details.

  1. Rule 2(c) includes a permanent employee of the company(who has the ICWAI qualification), in the definition of cost accountant. So he is allowed to certify the compliance report that the company maintains appropriate records. To be fair, this is pari materia with the secretarial record keeping, which a company secretary in employment can certify. But it is absurd, because the form of declaration('Form B' does not merely ask reassurance that records have been maintained. The wording is nearly a replica of what the statutory financial auditor has to give. I do not understand what they wish to achieve here. Do they expect a permanent employee to admit that 'I/We have/have not obtained all the information and explanations, which to the best of my/our knowledge and belief were necessary for the purpose of this compliance report' or even that 'In my/our opinion, the said books and records give/do not give the information required by the Companies Act, 1956 in the manner so required.'. Such matters of opinion should be left to professionals in my opinion. 
  2. IT companies(!) will be covered under the definition of processing activities under Rule 2(l)(xi)-(xii). 
  3. Mere value addition or services,  are brought under the ambit of 'production activity' under Rule 2(o)(iii) with this masterpiece  “Production Activity”  includes any act, process, or method employed  in relation to -(iii) creation of value or wealth by producing goods or services
  4. It is common knowledge that the reconciliation statement in Cost Audit report, is often the starting point of any indirect tax inquiry. But this was not explicit from the format etc. Now, the Govt has dropped the pretense and added a footnote below the reconciliation statement format, to make the department's job even easier.  That footnote reads -----------------------------------------------------------NOTES:(i) For produced/manufactured product groups, use the nomenclature as used in the Central Excise Act/Rules, as applicable.(ii) For services groups, use the nomenclature as used in the Finance Act/Central Service Tax Rules, as applicable.

Friday, June 24, 2011

Financial Markets Trading-WAY beyond terminals and phones

Popular perception of a trader is someone who works in a vegetable market. Those who have read 'Liars Poker' or watched 'Wall Street' may have a slightly refined impression of traders, as those who trade commodities over the phone instead of on the floor. For this, the only necessary skills seem a finely honed sense of prices, sharp negotiation skills etc. These skills ARE necessary but not sufficient, and do not explain the outsized pay which traders command. In this post, I share my understanding of what traders do.

Those of you with demat/trading accounts would have probably placed online orders/called your sub broker with orders. Either way, the order goes to a central trader who then executes at the best rate possible. Do not confuse those traders('retail interfacing ones') with the investment banking traders here. People will place online/telephonic orders only when the item is in existence, and traded on a liquid market. Both these conditions are routinely violated in complex products(where the real 'juice' is). After the sales guy 'sells' the trade idea to the client who then closes the deal with a recorded telephone call to the trader, who then 'manufactures' the trade idea, transfers it to the sales guy at a predecided price, and then profits on managing the risk.

Suppose the client needs to hedge a certain exposure, and approaches his salesperson at XYZ bank.The salesperson confers with the Structurer and Trader, who then decide that a certain product combination is best(say a options, b futures, c swaps etc). The trader would then price that product, using his client knowledge to decide the spreads to charge. The salesguy then follows up with the client to close the trade. For large trades, the trader/structurer often need to accompany the salesperson to the client presentation, and be ready for Q&A/emails/termsheet requests/presentations.  If it involves sacrificing weekends, so be it.

What I have described mainly relates to non FX OTC deals. In FX, the markets are liquid and largely exchange driven. It is the markets in credit, commodities and rates which are more OTC driven. And OTC transactions need a very high quality of people, with both technical and client facing skills(which prop traders hardly need!).

Banks DO have a strategy beyond 'make money in all ways possible'

IN Bschool, strategy is seen as this vague and ‘cover all’ term while banks are seen as this specific, numbers driven,  ‘business as any cost entity’. While perusing bank annual reports, I noticed that they did outline their strategy clearly. I put that down to 'boilerplate' and 'globe'. So after interactions with those in industry, and a few books,  it did surprise me that banks are selective about what they do, and whom they transact with(this is beyond the normal business controls like credit checks, RORWA cutoff etc). 
When one thinks deeper, the reasons are not far to seek. There are so many oppurtunities out there that a bank has to bind itself to atleast which client profile/geography it will chase. No balance sheet is big enough for taking all opportunities out there, and this would lead to intra firm tussle about who should hog the maximum share of the balance sheet. That is why a bank needs a strategy, to pre-empt this zero sum game, which destroys value, and takes away precious time from the rainmakers. 

So how are the target business segments chosen? The dream transaction is a riskless highly profitable product, transacted with a reputed clueless client. The highlighted words are explained below
  1. Riskless- transaction banking(trade services), broking etc has just operational risk, with lower funding requirement. In this capital starved world, with more stringent capital calculation norms on the anvil, banks are preferring business which uses up less capital. For example, secured loans, Islamic finance. 
  2. Highly profitable: This needs no explanation. But the word 'highly' is because with deals becoming rarer and more difficult to get approval(both for client and bank), one should focus on high profit deals. 
  3. Reputed client: Marquee names count, so do leagure table points. Also, some anchor clients give industry expertise(like IPOs for State owned enterprises open up the chance for private sector business) or market access(like Glencore). 
  4. Clueless:- As I blogged earlier, everyone likes an ignorant client, to use that information asymmetry.
Doing just any positive NPV deal is no longer the 'in thing'. With increasing scrutiny from NGOs and investors, deviations from strategy can cost the bank heavily in terms of shareholder value. Think of the banks involved in funding the Libyan dictator Gadaffi, or those who helped people launder money in offshore locales. Noone would welcome the media exposes and leaks.

The tale of 2 campus placements-will mandatory cost audits change things?

From the website of the Western India regional council of the ICWAI, I retrieved the most recent placement statistics from page1 of the journal(http://www.icwai-wirc.org/pdf_files/June%202011.pdf).

Contrast this with the placements of the ICAI(retrieved from the campus placement report for Feb-11'Mar-11, reported on Pg 1724, of the May-2011 CA journal 35% of the candidates finally accepted the job offers.

The pan India ICWAI placement figures are not available, but I suspect that will portray a worse picture, considering that the best paymasters are typically in the Western Region(Maharashtra, Goa, Gujarat).

Why is this? Till recently(2007), as any informed person would attest to, getting the ICWAI certification was quite easy compared to CA, and the curriculum was dated. While one may say that given the (often) considerable work experience profile of the candidates, they would anyway be knowing the relevant costing practices etc, this did not reflect well on the course. Add to that the notoriously inefficient administration, Kolkata HQ(and concurrent attitude!) and the trend of blindly aping the exam papers of other institutes, and you see why this had happened. Employers did not much rely on the ICWAI qualification, and those who got it were typically those with considerable experience, who considered it an added feather on the cap.

Since 2008, things have changed. Administration has improved and become more student friendly/responsive, there is a world class curriculum in place, and there is the requirement to do a mandatory 3 years internship(or workexp in lieu of that). That should address the supply side-both quality and quantity wise. The Indian Government obliged the profession by making cost audit mandatory. While opening the floodgates to cost auditors, the real juice may seem in the added services like efficiency assessment etc. But there, they do face a competition from CAs and management consultants.
My conclusion: Cost Accountancy firms will mushroom, but the corporate demand for Cost Accountants is unlikely to go up. While firms will pick up candidates, they would not match the industry pay. So this state of affairs is likely to continue atleast till companies realize that they need cost accountants, in addition to their existing accounting/finance professionals.