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 One of the first things that came to mind when I read the article was that why has there been dominance by the Big 4 in the industry for so long and why have other so called second tier firms not been able to move to the next level and join the Big 4. The Big 4 must be doing something right to maintain their position in the market, for so long. Yes the rankings do change, but only within the Big 4. It is EY leading the race in audit and advisory as per revenues or number or accounts one year or it is KPMG or PwC or Deloitte another year. The competition has not really moved outside the realm of these giants. Is there too little choice then for public companies when it comes to picking an auditor? Do you think that the bigger public companies are actually complaining? Surprisingly they are not. In a report published by the Government Accountability Office (GAO) in 2003, many of these firms do not look beyond the Big 4 to provide them various services. It is also surprising that not many of the public companies that require the services of these giants are actually complaining about lack of choice.

So what makes the Big 4, the Big 4? The differentiating factor according to me lies in the attitude of the top leadership, the values of these respective firms, and the hunger that these companies share, that keeps them at the top of their game. Their firm belief and clarity on what they stand for is what drives their working. They share a common hunger and passion to expand. Their internal foundation is so strong that the quality of the work they deliver is incomparable to any of the smaller firms. Every piece of work that is sent to the ‘client’ undergoes multiple rounds of reviews and checks and a very serious effort is made to deliver the best possible report or in Big 4 terms- a ‘Deliverable’. Yes there have been lapses in the past with Enron, WorldCom etc but the number of these lapses have been so few and sporadic.

So now what about the tier 2 firms and smaller firms? Looks like they will have to keep working harder and take a more aggressive approach to getting new accounts or be satisfied in ruling their own space, because lets face it…the Big 4 are here to stay!

In wake of sub prime crisis, we have been continuously reading – “Asset Backed Commercial Paper’s are still shrinking..; Interest rates on ABCP’s are rising ; FED provides auction window to banks for their ABCP’s.. etc etc but what are really Asset Backed Commercial Paper’s.

So here’s the fundamentals on ABCP: Commercial Papers are generally short term unsecured commercial debt securities issued at high interest rates. However, if the same instrument is backed by a steady flow of income from an existing ‘asset’ it makes the product more secure and provide an avenue to the issuer raise debt at lower cost.

The ABCP’s are primarily issued by organizations to release their locked ‘receivables’. For example, if a company has provided a short term loan, it can protect itself by setting up a conduit (a special purpose vehicle). This SPV will purchase the receivable and issue an ‘asset backed commercial paper’ to investors (who purchase at market determined interest rate). Thus, in bargain the originator, receives the loaned amount (from SPV) and passes the default on to the conduit. Though, it seems like just another form of ABS and or a CDO except the duration is for very short period, hence comparatively safer. Till the obligor is paying their obligation (i.e., principal and interest), investors are safe. If the obligor defaults, the conduit may default as well.

Once ABCP market was higher than $1.3trillion, now due to market collapse and rising interest rates, investor have been reluctant to invest in the product. As of 20 March data, the ABCP market has shrunk to about $800million. Almost 40% from its peak.

Lucy sets the ball.

Charlie Brown goes to kick the ball.

Lucy snags the ball away.

“Oh, good grief!”

Does this remind us of Wall St. vs. Main St.?

As long as there is a “Lucy” to present an opportunity, there will always be a “Charlie Brown” to fall for it. Similarly, there will always be increasingly complex derivatives and people to invest in the derivatives. It’s only human nature.

Humans learn from time to time, however, just when we do, something new comes along to deceive us. Nowadays, investment banks are hiring lawyers for the sole purpose of drafting ever-complex financial derivatives.

What’s the problem? Well, how do you value a contract that the salesperson doesn’t even understand? And if the goal is profit, where’s the incentive to be truthful? This poses a tremendous problem when recording long-term assets. Sure more regulation would be nice, but how likely is this going to happen?

At least conservative buy-side analysts are on our side, right? Good grief.

First, a joke (disclaimer: I didn’t write this, but found it here):

There are two sides to a bank’s balance sheet – the left side and the right side.
The problem is that, on the left side, there is nothing right,
and on the right side, there is nothing left!

This joke may be hilarious now, but a few years ago, not many bankers were laughing.  In 2007 and 2008, banks were watching as their marketable securities (more specifically, mortgage-backed securities) were adjusted to market value (mark-to-market pricing). These adjustments were resulting in serious, unexpected losses for banks.  The bank’s “valuable” securities were not so valuable anymore.  To balance the balance sheet (as assets decrease, so must liabilities), banks started loaning less (aka “credit crunch”).  Furthermore, lenders who were given MBS as collateral wanted their money back from banks (these MBS investments were not looking so prosperous anymore).  We all know the end to this story (think Lehman Brothers and a global financial crisis).

In a boom, mark-to-market pricing is great as it increases the “real” value of a bank’s (or, say homeowner’s) investments.  But in a bust, the value of these assets falls very quickly.  Why didn’t accountants catch this? Why weren’t financial analysts with their fancy models shouting warnings?

Because these people are human, and sometimes humans see one thing, but choose to believe another.   The title of Steve Lohr’s New York Times article enforces this idea: “In Modeling Risk, the Human Factor was Left Out.”

As long as there are people who want to make money, but not lose it, there will be bubbles and financial crises — even if we have the models to “predict” them.  Emanuel Derman states in the article, “The models were more a tool of enthusiasm than a cause of the crisis.”  The very models that should have implied, “things are going to get bad!” people interpreted as, “quick, make as much money as you can while things are good!” As the article states, in the good times, Wall Street will chase profits.

Andrew Lo, director of M.I.T. Laboratory for Financial Engineering, suggests more restraint, and better regulation, could have helped smooth the impact of the bursting housing bubble.

Perhaps a history lesson would have, too.  Before Wall Street ever had sophisticated models – in fact, before there was “Wall Street” – humans were creating bubbles.  For example, the Tulip bubble in Holland in the 1630s and the South Sea bubble in England in the 1790s.  During the Tulip Mania, tulip bulbs were so valuable the Dutch would trade 12 sheep (a valuable asset) for just one bulb.  (Substitute “tulip bulbs” with “real estate,” and “12 sheep” with “more borrowed money than you can afford to pay back,” and you have the same scenario today.)

So who is to blame?  Accountants, hedge fund managers, bankers, analysts, homeowners?  Try blaming mankind itself; as long as there are humans, there are going to be accountants who mark-to-market, hedge fund managers who short sell and homeowners who borrow more than they should. And there will always be another bubble (bonds anyone?).

The whole issue of not choosing to honors gift cards of customers may turn out to be a serious one, especially if this continues to be a trend for companies filing for bankruptcy. The most worrying factor in the whole issue is that why is there no regulation or law that disallows companies from doing so. There should be absolutely no scope for any company to decide that it will not redeem the gift cards.

I somehow get the idea that Jim Babb, the spokesperson of Circuit City almost expected applause when he made the statement that Circuit City would honor all gift cards irrespective of when they were bought. To begin with, it is the obligation of the company to honor all gift cards. Forget the law and all the possible accounting standards we could introduce, but is there anything that the consumer or customer has done to fight this. How about a consumer forum where customers can join forces, voice their opinions and ensure that the concerned governing bodies take action against such companies? These distressed customers probably still won’t be able to get anything out of their existing cards but they can save millions of other customers from being cheated in the future and prevent companies from taking this so lightly.

Now coming back to accounting, I definitely feel that FASB should introduce some standard or guideline to accommodate or better still treat these customers with valid gift cards as creditors of the company (or something on those lines), in the near future. Clearly this is a loop hole that companies have been taking advantage of, it has to be stopped and stopped soon.

As retailers sell more gift cards consumers are losing out. There are some major retailer which have gone bankrupt due to mismanagement and consumers who had purchase gift cards of those companies would have a very difficult time to claim that money back. Most consumers gives up on the process and does not proceed to the bankruptcy court.

Gift cards should be redeemable regardless of bankruptcy. It should be accounted in the company’s financial so that it will allocate a portion of goods or money just for Gift Cards. If a company is about to go bankrupt, it should allocate some resources for giftcard refunds or if the customer wants to let them purchase items until the actual closing of the store. Then during bankrupcty ruling, customers with gift cards should be able to send in their cards to redeem the cash spend to purchase it. Thus retail company should have an amount of money set aside if it is moving towards bankruptcy.

The use of third party sites to facilitate the exchange of gift cards is a very good idea because this will help those who do not see a need to use giftcards that they have to exchange with someone else for a more useful giftcard. These websites will decrease the effect of consumers not spending their gift cards as well as consumers losing out when retailers bankrupt.

While I agree with Justin’s initial statement about the impersonal nature of gift card giving, another aspect of the article caught my attention.  Toward the end of the article, Brian Riley (senior analyst with TowerGroup) was credited for saying that “a large part of the problem is that the accounting practices regarding the sale and redemption of gift cards by retailers are not standardized.”  This line piqued my curiosity to look at how retailers account for gift cards.  I turned to an article in the CPA Journal Online from November 2007 entitled “Gift Cards and Financial Reporting: Unwrapping the Uncertainties of Revenue-Recognition and Other Issues” by Ronald E. Marden and Timothy B. Forsyth — http://www.nysscpa.org/cpajournal/2007/1107/essentials/p28.htm.

This article digs a little deeper into the question of breakage income – at what point can the company decide that the card will not be used and can, therefore, be recognized as income. The article discusses the practices of big companies and cites the examples of as Best Buy, Home Depot, Circuit City, and Wal-Mart. Each of these retailers has a different system, outlined in their financial statements’ footnotes.

In the end, the article’s authors recommend that companies recognize breakage income based on “prior experience provides substantial evidence that cards meeting certain criteria will never be fully redeemed.” Ultimately, the authors strongly suggest that FASB take action on this issue and I agree.

As we have discussed in class, Hurricane Katrina was classified as “ordinary” for accounting purposes because hurricanes are not infrequent in Louisiana.  The article points out that it is nearly impossible to classify something as infrequent noting that:

One accounting textbook terms them “so restrictive” that they can include only “such items as a single chemist who knew the secret formula for an enterprise’s mixing solution but was eaten by a tiger on a big game hunt or a plant facility that was smashed by a meteor.”

It does make sense to make it very difficult to classifying events as “extraordinary.”  If it was easy, managers would likely manipulated financial statements as users often ignore “extraordinary items” as one time charges unlikely to be repeated.

While hurricanes to occur in Louisiana, I think that Katrina can still be classified as extraordinary due to what occurred after the hurricane passed.  Katrina in itself, I will acknowledge, should not be classified as extraordinary.  One can argue that it was the aftermath of Katrina, and the controversy surrounding the handling of the disaster, that can be classified as extraordinary.  Perhaps the delays in clean up, and the demographic shift of people out of New Orleans, had a more long term financial effect on the city.