The Accounting Mirror

Ramón Gurriarán

1 November 2002

Corporate accounts have received wide media play in recent months. This old subject has in the past been viewed with a certain disdain, or has at best been ignored. Now it seems that not a day goes by without certain accounting operations leading the news.

The most recent relates to losses reported by Telefonica in the first half of 2002. These were caused by several factors, among which are the provisions made by the company of the value of its assets, such as its UMTS licenses, and the depreciation of its assets brought about by the crisis in Latin America. Companies frequently make this type of accounting entry, but what seems surprising in this case is the size of the losses: over €5,574 million.

Going beyond the figures, it’s worth examining the meaning of this accounting operation and the parallelism that ought to exist between reality and the corporate books. To go even farther, accounts should always mirror corporate reality. For this we return to the year 2000, when Telefonica, together with other operators, decided to invest heavily based on expectations opened up by third-generation mobile telephones, or UMTS.

From the accounting point of view, investments made in purchasing and developing these licenses must be treated as assets, and therefore must appear on the balance sheet. Nonetheless, the difference between investment and cost does not depend on the amount but on the future capacity for generating income – something which must not be forgotten. At the time, UMTS seemed the gateway to a future full of business opportunities that would generate income on an ongoing basis. It seemed logical that the amount paid for the licenses should appear on these companies’ balance sheets.

However, an asset’s value need not necessarily be indefinite. What is more, it is common for assets to gradually lose value throughout their lifetimes, due to technological or physical obsolescence. In such cases, the loss is entered as an expense. In this way, firms’ profit-and-loss accounts reflect the progressive loss of value of their assets as an expense, through what is called accounting depreciation – really nothing more than an accounting entry, without involving a cash movement.

[*D Accounts should always mirror corporate reality *]

Problems arise when assets do not realize their capacity to generate income, or when doubts exist about them. In such cases, from the accounting point of view, the situation must be admitted, reducing the asset’s value and reflecting the lower value as an expense in the profit-and-loss account. Technically, this is not depreciation (which is a systematic loss of value), though it has an impact on the company’s profit-and-loss sheet, as we saw in Telefonica’s case. Again, this accounting option involves no cash movement. So what implications does it have on a firm’s financial health?

It is obvious that somewhere along the road between purchase of the licenses and recognition in the accounts of their lower value, Telefonica invested in resources whose recovery seems difficult. Yet the fact that it reflected this situation in its account books does not make it change. Reality does not differ for these reasons, and however much a director persists in making it seem otherwise, accounts will never alter reality.

All the same, it is a good sign that after events of recent months, a company like Telefonica has brought its accounting data more in line with reality. Perhaps this will help us appreciate the importance of reliable financial information when making decisions. Quality information is the main asset of any financial market, and we are currently in a period where provisions have been made with respect to this asset about which there are doubts – speaking, again, from the point of view of the company’s accounts. Hopefully, decisions like Telefonica’s will help the company recover their value, and with it the confidence of their investors.

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