Eureka Correspondence

Big four accounting, clarifying commodity calls, and biotech risks.

Accounting and the big four

The article Three weak spots in the big four discusses the accounting treatment of computer software costs. My understanding of the Tax Act is that their treatment is in accordance with the Act. The article clearly implies that to not write of the software costs in the year of purchase is a little trick designed to improve the current profitability of the bank. However, as this is contrary to the provisions of the Income Tax Act I don’t see that they have any choice - nor would they have changed their practice in recent history.

Having said that, it’s true that the decision as to the effective useful life of that software is a subjective one and is open to interpretation. The longer the useful life, the lower the annual expense booked to the profit and loss. However this is not sufficiently significant to justify the conclusions in the article.

But the general tone and thrust of the article is, in my opinion, misleading.

Bruce Williams

Justin’s response: Thanks for your comment. The article makes the observation that capitalised software has grown at a much faster rate than overall asset growth for the banks. This implies that the banks are capitalising more than they used to historically. This could be due to under-capitalisation in the past or over-capitalisation in recent periods. We are of the view that it is more likely to be the latter rather than the former. It is important to also remember that the capitalisation of software for the purposes of statutory reporting does not have to (and generally does not) align with tax reporting, which leads to the recognition of deferred tax assets and liabilities.

Based on the reported financials from each of the banks, we have estimated that the useful life being used by each bank has materially increased in recent years. As you correctly suggest, an increase in useful life does lead to lower annual expenses. It is this combination of both higher software capitalisation coupled with lower software amortisation that assists us in forming our conclusion that the quality of earnings that are coming through are now deteriorating.

Steering clear of commodities

In Carr: Seven calls for 2014, Adam Carr says to “steer clear of commodities”, and then goes on to say: “If regulators drop the ball, or the market finds a way around it, commodities would rise sharply.”

Do these two comments contradict each other, or do I not understand the article correctly?

William Davis

Adam’s response: Thank you for your letter. The point I was making is that despite all the positive fundamentals that support ongoing strong price growth, there is too much political and regulatory influence at this time for retail investors. If that regulatory influence continues, speculators will continue to avoid commodities and the major commodity groups (crude, copper etc) will probably just range trade. However, if that regulatory interest stops for whatever reason, then we can expect key commodities to join the global equity bull run. Given the high degree of political risk, I think there is a better entry point (maybe next year) for retail investors to get back into that space.

Stem cells and Universal Biosensors

I recently bought Universal Biosensors (UBI) after reading your article on the biotech, but it occurs to me that Mesoblast (MSB) is working on stage two stem cell treatment for diabetics. I just thought this has to have competitive pressures for Universal Biosensors – which increases risk.

If you had any thoughts on this as a guide, that would be very much appreciated.

AY

Brendon’s response: Thanks for your query. There are a lot of challenges facing UBI that I would be keeping an eye on, but stem cell therapy isn’t one of them just yet as that is more a long-term threat. While what Mesoblast and its peers are doing is revolutionary, the truth is stem cell treatments are still years away from hitting the market - and that is assuming that all other clinical trials are successful. That’s really a big assumption.

National productivity efforts

I’m concerned about the fact that Australia is actually a high cost country, not necessarily because of high wages per se, but because of the way we go about things.

Let’s look at two countries, Australia and Germany. These two countries have of all developed countries emerged out of the GFC fastest. Australia managed it because of China and Germany because of Germany. Australia received ever increasing orders for natural resources from China and used the opportunity to invest heavily into mineral capital projects. The employment of thousands of sub-contractors kept the unemployment rate reasonably steady, despite of all the talk about the two speed economy. Great, but the remainder of Australia has not progressed.

Germany emerged very quickly, because Germany has everything the world needs to rebuild itself after the GFC. It’s reasonably the only developed country in which the unemployment rate after the GFC has dropped below pre-GFC levels. Why did this happen? The answer is an exercise in improving the national productivity levels.

National, because no sector was exempt. Even the government had to look at how the taxes it has to collect can be collected in a less punitive way.

Years before the GFC the German government believed that the country was moving in the wrong direction and appointed a high ranking committee under a gentleman called Harz. I want to cut this short as all the actions the country undertook can be studied from publically available records. It took a few years to move through phases called Harz I, Harz II and Harz III. But the exercise was completed before the GFC hit. This was, of course, extremely lucky, but it has born its fruits.

The details of the productivity exercise could be studied by the Australian government and then tailored to our conditions here. Whether, of course, our government actually has the spine to engage on such a drive remains to be argued about. Such a productivity exercise is surely overdue here and we shouldn’t wait any longer.

I feel our practice of looking at individual sectors such as the building or automotive industry misses the point and will bear little fruit.

Edwin Matiuk

Retired Managing Director of Siemens Plessey

Related Articles