That Britain’s premier retailer TESCO was in news when they recently announced interim results, which show a fall in pre-blogtax profits of 92%. The key part of the statement is that

Amounts have been pulled forward or deferred, contrary to Tesco Group accounting policies; there have been similar practices in prior reporting periods; the current and prior practices appear to be linked as income pulled forward grew period by period

The basic issue here is profits are recognised early and/or costs are recognised late. It is easy to see how the problem snowballs. Say the company is struggling to meet a quarterly earnings target. Profits are brought forward and the target is met. But of course those profits would have accrued in subsequent quarters so new wheezes need to be found to keep profits rising.

I think a lot of accounting goes like this…

Estimate what your competitors will report. Your competitors might be external companies or managers you compete with internally.

If you think you can easily beat them, you add some prudence such that your result comes out just above theirs.

If you can’t, you relax your (hopefully prudent) assumptions from previous quarters.

Of course if everyone does this, the strategy is doomed to fail. You end up with extremely volatile reporting patterns. The market chases itself up and then crashes violently when there’s no more slack left.

Some Lessons that can be shared from MF Global’s death those who remember,

  • Accounting loopholes have to be closed and oversight improved.
  • Nonbank financial firms should have a lead regulator.
  •  Rule-writers should consider “nonsystemic” firms as well as “too big    to fail” banks.

There was a deadly combination that I came through during MF global failure:

Another deadly combinations includes :

  • Actuarial Approach – You to work hard and do sound credit analysis.
  • Market Based Approach – CDS & Derivatives. – Model based approach where lots of corners are cut.

When you institute the Market Based Approach which really is a house of cards approach, any lose in confidence is deadly. – Lehman/BSC/IKB/Irish/Islandic Banks.