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Africa’s Economic Evolution

Many pathways, some of them dead ends, weaved Africa’s economic story – a story of investment, unlocked natural capital, complex adaptive process and competitive struggle for survival, with modest accumulation. What we are left with is today’s mix of medieval-with-modern economic modes.

Underperformance is the leitmotif of contemporary state-dominated economies. Nonetheless, Africa has grown, illustrating the power of multiple economic entities over the political regimes that impede them. This relationship is the root cause for optimism about future growth.

Most interpretations presume that Africa is poor. This is not true. Africa is not really ‘poor’ as many portray it: it is poorly managed and yet-to-be-developed. Vast potential lies in abundant natural capital and resource-based industries, the full monetisation of which could provide for enhanced long-term growth. Until this occurs, talk of an ‘African Century’ and proclamations of an era of strong and sustained growth are premature.

Lessons from Africa’s past show that long-cycle growth is central and sustained capital accumulation essential to this process. Capitalist evolution over the long-term has been at the core of modern progress to date.

La longue durée
Africa’s economic future will be shaped by the continent’s formative evolution, a view much neglected in contemporary projections.
GDP and income per capita data for the past 2 000 years, crafted by international scholar Angus Maddison, are our best source for past trends (the data is shown in real 1990 US dollars, updated to 2010 using official data, and the methodology is found in Africa’s Future: Darkness to Destiny, Profile Books, 2012).

Maddison estimates that when Rome commanded North Africa in 1ce (common era, previously referred to as ad or anno domini), Africa’s population was 17 million. By 200ce it was 20 million, with half in the far north. It took 1 000 years to reach 32.3 million, and a further 500 years to become 46.6 million. To 1500, the average annual population growth rate was barely 0.06 per cent. Malthusian realities prevailed. At 1ce Africa’s annual per capita income was $472; by 1000 it had fallen to $425. In 1500 it was even lower, at $414, showing that most of Africa went backwards for 1,500 years – a salutary lesson in the result of ultra-long cycle stagnation with chronic decline.

Overall, from 1500 to 1820 Africa’s economies flatlined: in 1820 GDP per capita was $420 (population 74 million). The post-1700 continental economy concentrated in the south, around the Cape, with growth poles on northern littorals. Living standards in tropical interiors were worse. Monetisation was minimal. This was an era of unremitting stasis, begging the question: how did Africa cut the Gordian knot of material misery?

Subsequent growth came mainly from capitalist penetration into a few locales on the edges of Africa. From 1820 to 1870 Africa achieved real GDP per head growth at average annual rates of 0.58 per cent, as opposed to the 0.05 per cent of the period from 1500 to 1870. This first notable long-run cycle of growth enabled per capita income to rise to $500 by 1870. Adding just six per cent to average real income in 1ce of $472, it reflected recovery post-1500. Africa’s long-run growth cycle, now marginally positive, was still chronically abysmal. Tough conditions dominated traditional Africa as population numbers (110 million by 1900) placed pressure on real income per capita.

From 1500 onwards, Africa continued on a subsistence level, except in isolated zones. Abundant land, scattered populations, slow demographic transition, weak rural economic landscapes, nomadic pastoralism and migration to more benign ecologies enabled its varied subsistence world to survive, though under austere conditions.

Eventually all this fractured and the storyline for ancient, bare-bones economies became one of disruption with relative disintegration. Yet the millennia-old, embedded subsistence economies, although ruptured by late-19th century colonialism, did not crumble entirely. Nor did early modernity herald a quantum shift in economic progress. Old and new had to cohabit Africa’s economic space. This fateful inner schism formed the drama of the century to follow and remains today.

Africa’s opening
Africa’s engagement with the world saw real income per head reach $637 by 1913. GDP grew 0.61 per cent annually between 1870 and 1900, but only 0.46 per cent between 1900 and 1913 as the population grew to 125 million. Compared to 1820, there had been a 50 per cent rise in income per head. Still, long-term cyclical growth was slow, at only 0.6 per cent per annum from 1870 to 1900. This was presaged by the fundamental switch from rural subsistence to more varied economic foundations as more natural capital was unlocked.

Colonisation brought major capital investment. By 1950, with 228 million inhabitants, income per head was $889, growing over the period 1913 to 1950 at 0.91 per cent annually – a significant relative shift in growth and income standards overall. But substantial shocks wracked traditional economies, etching new patterns of capital formation and income differentiation into economic land-scapes. Lifestyles of the rich contrasted sharply with those of the preponderant poor. Even the middle classes attained income standards that Africa’s potentates had not enjoyed.

This became Africa’s first real period of solid long-run growth. Important institutions and technical advances from elsewhere were brought to Africa and transformed its economic destiny – in capital markets, companies, factories, literacy, electricity, railways, infrastructure and organisational capacities

By 1960, GDP per capita was $1,055 (population 285 million). Investment was still sizeable. Growth flowed from large foreign capital inflows, domestic investment, infrastructure spread, economic linkages built inside Africa and with the world outside, as well as from technologies to augment the scale and efficiency of the capital stock. Capital-to-output ratios had risen, while more land was made commercially viable as technical coefficients and productive efficiencies improved.

Pre-market economies became smaller in terms of GDP measurement. Land surpluses were of less significance in the wider capital asset base. Urban-industrial and skilled workforces enabled increased productivity and even exports. This amounted to a revolution across Africa. More transactions than ever were conducted in monetised form and Africa became more extensively connected to global evolution.

Whatever the rationale of this imperialist era, it induced the growth and industrialisation that reconfigured nascent and previously backward economies. Yet Africa’s ‘winds of change’ blew again.

Post-colonial Africa
Decolonisation brought abrupt changes in regimes and expectations across Africa. This watershed resulted in major disruption and decay in many state institutions and economies. Still, the early years of independence, coincident with a global economic boom, witnessed growth.

GDP per head rose to $1,181 in 1965, $1,335 in 1970 and $1,515 in 1980. On the long-term cycle, annual growth rates of 1.8 per cent were achieved between 1960 and 1980, although this modest outcome was dampened by demographic expansion. Employment growth rarely matched the numbers entering Africa’s labour markets, and structural unemployment reared its head. Informalisation proliferated in step with the weakening capacity of traditional economies to provide subsistence. After the colonial interregnum of but 70 years there emerged the struggle for survival: of the fittest, fastest, favoured and fattest.

By the time the turbulent 1980s and 1990s came around, mistakes by newly-emergent nation states in economic management, with multiple civil conflicts and wars and struggles for Cold War control, took a heavy toll on living standards. Africa went downwards: by 1990, GDP per capita slipped to $1,425 (dropping $90 a head), while the continent’s population rose to 633 million.
It took a decade for recovery to transcend demographics and break above the 1990 per capita level, at $1,447 in 2000 (still below 1980’s real level). In effect, Africa experienced two lost decades, with a huge cost to the long-run cycle. Annual growth per capita for the period 1980–2010 was only 0.7 per cent.

Only during 2000–10 did Africa show much mettle, witnessing its most productive period, allied to the world commodity boom. By 2010 real income per head was $1,870, with the continent’s GDP at about $1.9 trillion and a population of 1.05 billion. The annual income per head growth rate was 2.36 per cent – positive, but no miracle. This left average income per capita at only $5.12 a day.
During Africa’s post-colonial era (1960–2010), GDP expanded six times from $300–million, yielding annual average compound growth of 3.78 per cent. Yet per capita income only rose 1.15 per cent annually over the 50 years, a mark of demographic burden.
Looking at the past brings certain questions to mind. Was Africa’s growth rate ‘naturally’ inhibited at some ceiling over time? Are there upper limits to future growth and over what duration? The big picture question remains: what long-cycle growth rate can Africa expect to 2050? ❐

Author: Duncan Clarke. Compiled out of the book, Business in Africa – Corporate Insights, compiled by Dianna Games, Penguin publishers, recommended retail price (R260).


To Strike Or Not To Strike- the financial impact

The recent strikes at Marikana and its tragic loss of lives mark one of the darkest chapters in the history of our country. The ripple effect of what happened at Lonmin mining company may have consequences beyond what is currently foreseen. Paper, Rolls, Styan, Ashton and Wasserman (2012:9) state that the impact of the ‘Marikana massacre’ will be felt for many years into the future, particularly by the ruling party, union politics, industrial relations and policing.

Nevin (2007:64) commented that excessive wage increases could push inflation out of its 4% to 6% target range, with increased interest rates the inevitable consequence. According to The Economist Intelligence Unit (2009:11) in commentary on international risk rating, labour market risk plays an important role in determining the overall risk rating of a country. South Africa scored 57% (out of a 100% for maximum risk) in its 2009 risk rating for labour market risk.

Employees in South Africa currently face considerable erosion in their lifestyle levels and quality of life. This is due to, among other factors, increases in energy and food costs and the general upward trend in consumer price inflation. Workers seek relief from these economic hardships through the wage negotiation process.

In South Africa the major bargaining tool at the workers’ disposal is industrial action. In order for the wage negotiation process to benefit workers, it must leave them in a better position than if they had accepted the employers’ initial offer. The purpose of this article is to gain new insights in establishing the effect of industrial action on the income of workers.

According the Gini index, which gives a measure of the degree of inequality in the distribution of family income in a country, South Africa is ranked as one of the most unequal societies in the world. With South Africa being the largest economy in Africa, employees are becoming more restless in their need to gain better wages. Labour unions have justified their demands for above-inflation wage increases by pointing to the fact that workers need to feel an improvement in their living standards and not just keep abreast with inflation.

Approach and assumptions
For the purpose of accessing financial data, it was decided to use a case study approach and to gather the appropriate data from three big South African business institutions that had recent strike activity. Some general assumptions had to be made to facilitate consistency and comparability of calculations.

• The average remuneration in terms of cost to company in each case amounts to R130 000
• Employers have implemented the ‘no work no pay’ policy and lost wages due to industrial action are deducted equally over a three month period
• Salary negotiations occur in 12 month cycles
• The effects of taxation, both from a company and an employee perspective, are ignored.

Case studies
The profitability of embarking on a strike, from the viewpoint of the worker, is determinable by using both quantitative and qualitative factors. In this study we seek to measure only the quantitative gains of industrial action. The profitability of industrial action is measured as the difference between the final increase settled on and the employers’ initial offer. We measure the gain or loss in nominal terms and then take into account the time value of money by discounting the monthly gain or loss by the prime lending rate (at the time of the study being 9% per annum).

Each of the three scenarios is based on actual wage negotiations where industrial action was employed by workers as a negotiation tool. These are now briefly discussed.

Workers of this major publicly owned enterprise embarked on strike action in early May 2010 that lasted for 17 days, demanding an across-the-board wage increase of 15%. Management’s initial wage offer was an 11% increase. The parties finally agreed on the following:
• An 11% across-the-board increase
• 1% one-off increase in May based on annual salaries
• 1000 contract workers were to be given permanent employment by October 2010 and an agreement was reached regarding the placement of the remaining contract workers.

It was widely reported that the economy lost R7 billion as a result of the prolonged strike action. In this case workers ended up accepting managements’ initial offer of 11%, as it was significantly above the inflation rate of 5.7% that prevailed at that time. Although the settlement did result in employees getting a premium above inflation, the industrial action eroded those gains as a result of lost wages incurred during the period. The net result of the industrial action for workers was that they were worse off, both in nominal terms and present value.

Passenger Rail Agency of South Africa (PRASA)
On 17 May 2010 workers declared a dispute with management, demanding a 16% wage increase, while management revised its initial offer from a 3% to an 8% wage increment. The industrial action lasted for 13 days and 12 000 workers engaged in the strike, disrupting train operations of both Metro Rail and Shosholoza Meyl. On settlement of the dispute, the parties agreed on the following:
• A 10% across-the-board wage increase
• A 12.5% salary increase for Shosholoza Meyl workers earning less than R70 000 per annum
• A 12% salary increase for Metro Rail workers earning less than R70 000 per annum
• All workers would receive a one-off payment of R1 000 in June 2010.

Members of Automotive Manufacturers Employers’ Organisation (MAMEO)
On 11 August 2010, 31 000 workers in seven vehicle manufacturing plants embarked on industrial action. The strike lasted for 8 days. Workers demanded an across-the-board increase of 15%, while employers offered a wage increase of 7%. The parties agreed to the following:
• A 10% across-the-board wage increase
• Medical, pension and other benefits to be extended to short-term employees

The discontinuance of the use of labour brokers by January 2011. Table 1 contains a summary of the results and calculations for the three strike actions.

Table 1: Summary of results of three strike actions

Employers initial wage
offer 11% 8% 7%
Workers initial wage
demand 15% 16% 15%
settled on 11% plus 1% once-off on annual salary 10% plus R1000 once-off. 10%
Period of Strike 17 days 13 days 8 days
Annual salary after
settlement (A) (Note 1) R139 545 R141 970 R140 151
Annual salary adjusted
for initial offer (B) R144 300 R136 500 R139 100

Difference A – B
Nominal benefit/(loss) (R4 755) R5 470 R1 051
Net present value of
benefit/loss (Note 2) (R4 675) R5 102 R909

Note 1
This annual salary not only includes the increase settled on, but also the wages not earned because of the strike.

Note 2
For the purpose of calculating the net benefit or loss of the strike action from a worker’s perspective, the difference between what was settled on and what was offered initially was first determined on a monthly basis for one year. Using the bank rate of 9% (adjusted for a period of one month), these differences were then discounted to take into account the time value of money and added together in order to determine the present value of the net benefit or loss.

From Table 1 one can deduce the following:

The workers made a loss due to the length of the strike period and the low premium negotiated of 1%. The nominal loss was R4 755 and the present value of the loss amounts to R4 675 per worker.

The 2% premium negotiated, coupled with the R1000 once-off payment resulted in a nominal net gain of R5 470, and in terms of present value there was a gain of R5 102 per worker.

In nominal terms workers had a gain of R1 051 and when the time value of money is taken into account, a net gain of R909 per worker is calculated.

Duration of strikes and breakeven strike days
From the calculations contained in Table 1 it is clear that the number of strike days plays an important role in the financial outcome for the worker. The longer the strike is prolonged, the heavier the penalty of no pay and the greater the likelihood of a net loss from the worker’s perspective. Ndungu (2009:91) points out that the majority of strikes in South Africa since 1996 have been of short duration because of lockouts and the ‘no work, no pay’ principle.
The results for the three case studies are presented in Figure 1.1 and it indicates clearly that the breakeven strike days are 3 for TRANSNET, 27 for PRASA and 10 for MAMEO (rounded to the nearest full day). The greater the percentage difference gained by the strike, the longer the strike can continue before breakeven is reached. The graph clearly shows that there are net gains for strike periods shorter than the breakeven days and net losses for longer strike periods.

Figure 1.1: Net present value of benefit/loss relative to the number of strike days

Strike action has proven to have far-reaching implications – for economies, corporate institutions and employees alike.
This article attempts to shed some light on the feasibility of a strike from an employee’s perspective by analysing the wage increases and relevant strike data for three South African institutions that experienced strike action during 2010, namely TRANSNET, PRASA and MAMEO.
The findings are that for TRANSNET, purely from a financial perspective, the workers would have been better off if they accepted the initial offer and did not strike. For PRASA and MAMEO, the strikes did result in net gains for the workers and this was accomplished to a large extent by the relative short durations of the strikes.
It is also pointed out that the longer the strike lasts, the smaller the net benefits become in terms of present value and that a breakeven point in strike days is reached when the net benefits are zero.
If the strike carries on past the number of breakeven days, the negative impact of losing wages causes the present value of the net loss to increase in magnitude. ❐

Annual Industrial Action Report. 2010.
Paper, L., Rolls, C., Styan, J., Ashton, M. & Wasserman, H. 2012. What you have in common with a Lonmin miner. Finweek, 27 September.
Ndungu, S.K. 2009. Perspectives on collective bargaining in the global south. The case of South Africa. International Journal of Labour Research. Vol. 1, nr. 2:81-97.
Nevin, T. 2007. South Africa: Was the strike political muscle flexing? African Business. Aug/Sep:62-64.
The Economist Intelligence Unit, 2009. South Africa: Risk ratings. Country Monitor. July:11.

Authors: Johannes de Wet CA(SA), MBA, DCom and Gaisang Diale (BCom Accounting Sciences) Hons.

SA’s Mining Industry

According to a report issued by professional services firm PwC, a tough year for the mining industry lies ahead in the wake of recent industrial action, mounting cost pressure and shrinking profit margins. While the 2009-2011 period was characterised by a recovery in overall commodity prices from the lows of the 2008 financial crisis, in 2012 this recovery slowed, with gold the only commodity gaining value.

A weakening rand over the period managed to shield the South African mining industry from the decline, with prices remaining relatively flat. However, flat prices will not support the industry’s significantly increased cost base.

This article discusses highlights from PwC’s fourth edition of ‘SA Mine’, which published findings on trends in the South African mining industry. These findings are based on the results for the financial year ending in June 2012 of the top mining companies with primary listings on the JSE, as well as those with secondary listings whose main operations are in Africa. The selection criteria for this study included companies with a market capitalisation of more than R200 million and excluded global mining companies Anglo American and BHP Billiton, as these organisations do not necessarily reflect trends in the South African mining environment.
In general, of the 39 mining companies surveyed, industry balance sheets remained strong and with stable liquidity in 2012. It is however anticipated that significant margin pressure will result in a challenging 2013.

Market capitalisation
The 2012 financial year saw the top 39 mining companies shed all the gains made since the 2008 financial crisis. Market capitalisation for the top 39 declined by 9% from R910 billion in 2011 to R833 billion in 2012, reflecting a 3% decrease in market capitalisation of R862 billion in 2010. On the back of strike action, the position weakened even further and reflected a market capitalisation of only R792 billion at the end of September 2012.

The tragic events at Marikana and widespread labour disputes have significantly impacted the mining industry, with mining companies rethinking their risks and the risk landscape in which they operate. It is now imperative that they evolve their risk assessment practices to be more predictive in anticipating and planning for future potential risk events. Although these events were not the only factors that affected market capitalisation, they played a key role in the decline of the top 39’s market capitalisation by 5% from June 2012 to September 2012. Of the top 10 companies, six posted declines, with Anglo Platinum, Kumba Iron Ore and Exxaro Resources collectively losing R40 billion in market value.

Contribution by commodity
Coal overtook platinum as the highest earning commodity in South Africa. The report says that it is unlikely that platinum will regain the top spot in the short term due to the slower than expected recovery in global markets, the recent economic uncertainty and lower production as a result of industrial action. For the three main revenue generating commodities, gold is the only commodity to have gained in real terms, with the price of coal remaining flat.

Financial performance
Revenue increased by 16% in 2012 (compared to 36% for 2011) on the back of higher commodity prices and a weaker rand towards the end of the period. Gold companies reflected the best growth with a 25% increase, while platinum companies recorded a mere 2% growth. The remainder of the companies recorded average revenue increases of 22%. Operating expenses increased by 13% as opposed to the 18% recorded in the prior year.
Although the share of labour costs as a percentage of total operating expenses decreased from 39% to 36%, when one compares this year with the previous year, it remains by far the biggest component of the mining sector. Over the past five years, wage increases in the mining industry have not only superseded the CPI, but have averaged one to two percentage points higher than the national average of wage increases across all industries.

The changing risk landscape
The requirements of the King III Report on Corporate Governance have resulted in improved disclosure of risks by all organisations, with mining companies in particular excelling at disclosing these risks. However, Boegman says the challenge remains to link adequately performance and risk management and to put the necessary measures into practice. The regulatory, political and legal environment, followed closely by employee skills and safety, were among the most common risks disclosed by the companies included in their risk analyses.

Much has been made of the perceived inability of mining companies to meet the initial compliance targets set out in the Broad-Based Socio-Economic Empowerment Charter (the Mining Charter) for the mining industry, with compliance targets for 2014 set significantly higher than previously. Apart from the 26% ownership target, the required procurement spend with BEE entities of 40% for capital goods, 70% for services and 50% for consumables is bound to be a challenge.

The build up to Marikana and the ensuing industrial action across the industry has highlighted the need for mining companies to maintain direct communication channels with workers. The higher labour cost base, coupled with the contraction of mining activities, has already led to significant retrenchments and more are likely to follow. The report notes that the process of retrenchment and its effect on communities could aggravate the current spiral of negativity and sustained violence in mining areas and may lead to
political interference.

Mining developments have also led to an influx of people into mining communities, attracted by the hope of securing direct employment, or indirect employment in providing goods and services to mine employees. The limited resources of individual mining companies fall well short of community expectations, considering the scale of migrant influx, the lack of service delivery by local governments, the use of housing benefits for other purposes and the apparent inability of stakeholders to agree on social upliftment projects.

Furthermore, the availability of funds for capital expenditure is currently limited, with investors adopting a wait-and-see approach to the South African mining industry. Postponed or stalled capital expenditure may hinder the ability of mining companies to ramp up production in time to benefit fully from future commodity price increases.

On the other hand, over-optimistic long-term investment assumptions may result in inadequate cash flows to redeem debt, maintain equipment and reinvest in the business.

Safety in mines
Safety statistics indicate a higher level of focus on safety, and there appears to be only marginal improvement in this area. Of the top 10 companies that disclosed lost-time injury frequency rates, Kumba Iron Ore reflected the best record with regard to lost-time injuries. AngloGold Ashanti showed the best improvement over the previous year, while a total of seven companies improved their statistics compared to the prior year.

Improving value to stakeholders
The mining industry adds significant value to South Africa and its people. Stakeholders in the industry include employees and their families, unions representing them, the Government as regulators and custodians of tax income for the country, investors, suppliers and customers. The monetary benefit received by each stakeholder in the industry is usually summarised in mining companies’ value added statements. The state received 16% in 2012 (as opposed to 18% in 2011) consisting of direct tax, mining royalties and tax on employee income deducted from employee salaries. The report states that although the percentage of the value created by the state has declined by 2% from the prior year, the actual value of collections by the state for the represented entities remained stable in comparison with the 2011 year.

The percentage of value that is collected by providers of debt capital reduced marginally from 3% to 2%. This low percentage reflects the conservative levels of gearing in the mining sector. The 18% (2011:12%) received by the providers of equity capital increased from the prior year and reflected the volatility of returns to shareholders.

Boardroom Dynamics
Of the annual reports reviewed in this study, 33 companies disclosed the composition of their board members. An analysis of these companies found that the mining industry currently exceeds the minimum empowerment levels of board representation required by the Mining Charter.

Presently, 46% of board members comprise historically disadvantaged individuals. The Mining Charter requires a minimum of 40% representation by 2014.

Tax transparency
Globally, there is a drive to improve tax transparency with regard to tax payments made to governments and how those funds are utilised for the development and upliftment of those countries and their people. A range of transparency initiatives are currently in effect or being proposed, with the spotlight predominantly on the mining, oil and gas industries. These sectors often operate in developing countries and by demonstrating what they pay to governments in taxes and royalties in return for extracting natural resources – and what they contribute to the local economy – may be vital for maintaining important stakeholder relationships and a licence to operate.

Certain large mining companies have significantly amended how they report on tax, demonstrating that the business case for tax for transparency outweighs the possible risks. Companies are becoming more sophisticated in their approach, allocating greater resources to the governance and management of tax. They are also setting ‘best practices’ in their industries and are becoming more transparent about their corporate tax affairs, tax strategy, tax risk management, tax numbers and performance, as well as their total tax contribution and the wider effect of tax on the organisation.

Looking ahead, these trends are set to continue and intensify, as a diverse group of external stakeholders has become more interested in tax in the corporate sector and is asking companies to provide more extensive and varied information about their tax affairs.

In South Africa, a concerted effort is now being made to deal with acid mine drainage and its cost to the environment and affected communities.

Gone are the days when risks for companies were limited to health and safety issues. Mining companies now need to integrate risk and performance management.

The changed environment requires vision and leadership from boards of directors and executive management. These leaders will have to steer their companies through the near term low margin challenges, while recognising the impact on all stakeholders involved. ❐

Author: Hein Boegman CA(SA) is PwC African Mining Leader.


Doing business with China

Trade between China and South Africa has increased so rapidly in recent years that China has become South Africa’s leading trade partner. Chinese investment in South Africa has also increased rapidly, particularly in the resources and infrastructure sectors but also in financial services and information and communications technology. There has also been significant South African investment in China and this is expected to increase as China tries to build a larger consumer market. Investors need to be aware of the Chinese business environment including its accounting standards.

New PRC GAAP is the set of accounting standards issued by the Ministry of Finance of the People’s Republic of China and is expected to be adopted by all medium and large-sized enterprises across Mainland China within the next few years. It was first issued in 2006 and has since been updated to achieve convergence with International Financial Reporting Standards (IFRS). New PRC GAAP is not a direct adoption of IFRS but takes China’s specific situation and its economic, political and legal conditions into consideration. China has transitioned from an accounting system based on the needs of a planned economy towards one based on market economic principles.

Foreign Invested Enterprises (FIEs) in China generally prepare their group reporting packages under the accounting policies of their overseas parents (which is often IFRS) in addition to their PRC statutory financial statements. The accounting policies under New PRC GAAP may not be exactly aligned with the policies under IFRS. The table below illustrates possible reasons for the differences:

Characteristic Commentary
Certain options are permitted under IFRS but not under New PRC GAAP. New PRC GAAP reduces the options for accounting policies compared to IFRS. E.g., under IFRS both cost and revaluation models are allowed for subsequent measurement of property, plant and equipment and intangible assets but New PRC GAAP only accepts the cost model.
New PRC GAAP contains specific requirements on certain issues commonly encountered in China where IFRS is silent. Certain matters commonly encountered in China are addressed by New PRC GAAP even though IFRS is silent. E.g., for business combinations involving entities under common control, New PRC GAAP only allows a method similar to the pooling of interests method (carry over method), while practice under IFRS allows the carry over method or the acquisition method as IFRS is silent.
Certain specific requirements in IFRS, on matters not commonly encountered in China, are covered by general principles in New PRC GAAP rather than detailed requirements. New PRC GAAP does not include the detailed IFRS provisions for transactions that are not common in China. E.g., New PRC GAAP does not include specific requirements for defined benefit schemes as the retirement funds are similar to defined contribution plans.
There can be time lags between amendments to IFRS and New PRC GAAP, in particular where the IFRS amendment may be adopted earlier than its first effective date. After the issuance of new IFRS standards or amendments, the Chinese economy and stakeholder comments will usually be considered before deciding how to incorporate these into New PRC GAAP. E.g., if an overseas enterprise adopts IFRS amendments that are not yet reflected in New PRC GAAP, differences in the policies at group level and the FIE’s statutory financial statements will exist.

FIEs should ensure compliance with New PRC GAAP in their statutory financial statements. Simply adopting IFRS principles is not appropriate. The only exception permitted under New PRC GAAP is for a parent in China to combine IFRS amounts in the overseas subsidiary (which comply with the principles in the Basic Standard, which is the Chinese Framework equivalent) in its New PRC GAAP consolidated financial statements where there is a transaction encountered by the overseas subsidiary that is not addressed under New PRC GAAP. The following table summarises some important differences in recognition, measurement and presentation requirements between New PRC GAAP and IFRS.

Item IFRS accounting New PRC GAAP accounting
Financial year end Financial statements to be prepared annually (no specific year end). Financial year shall be from 1 Jan to 31 Dec.
Cash flow statement Entities can choose to present cash flows from operating activities using the direct or indirect method. Entities are required to use the direct method to present cash flows from operating activities and a reconciliation using the indirect method in the notes.
Non-controlling interests (minority interest) Accounting policy choice for measuring non-controlling interests that are present ownership interests and entitle the holder to a proportionate share of net assets on liquidation:
Fair value; or Proportionate share of the acquiree’s identifiable net assets
All other components of NCI shall be measured at acquisition-date fair values, unless another measurement basis is required by IFRS. Acquirer should always recognise the minority interest at the minority shareholders’ proportionate interest in the acquiree’s identifiable net assets
Consolidated financial statements IFRS exempts an unlisted parent that is itself a wholly-owned subsidiary of another entity (which prepares IFRS consolidated financial statements) from preparing consolidated financial statements. No exemption for parent companies.
Investment in subsidiaries (Separate financial statements) Accounting policy choice: cost or in accordance with IAS 39. The cost method to be used for investments in subsidiaries.
Investment property definition Property held to earn rentals, capital appreciation or both by property owner, lessee under a finance lease or lessee under operating lease (subject to certain conditions). Property held to earn rentals, capital appreciation or both by property owner or a land use right holder. A lessee under a finance lease or operating lease shall not classify the property as investment property.
Financial instruments: Extent of detailed
requirements Extensive explanations and examples for accounting for financial instruments and certain limited opportunities for reclassification. Basic principles are similar to those under IFRS but taking into account the particular situations in China, there are limited differences in the detailed rules, e.g. financial assets at fair value through profit or loss are not permitted to be reclassified.
Reversal of impairment loss Impairment losses recognised in prior periods for an asset other than goodwill should be reversed when the recoverable amount increases. Once an impairment loss is recognised, it shall not be reversed in a subsequent period.
Government grants related to assets Accounting policy choice to present grant as:
deferred income (recognised in profit or loss on a systematic basis over the useful life of the asset); or
deduction from carrying amount of asset Only the deferred income method is acceptable and the income shall be amortised to profit or loss on a straight-line basis over the useful life of the asset.
Share-based payment Addresses goods received in exchange for share-based payments and specific requirements on how to account for a transaction in which either the enterprise or supplier has a choice of whether the transaction is settled in cash or by issuing equity instruments Does not deal specifically with transactions in which goods are received or where there is a choice of
Segment reporting Only listed entities or entities in the process of listing are required to prepare segment reports. Other entities can choose to disclose segment information. Segment information should be consistent with that used internally by the chief operating decision maker. All enterprises are required to comply with the standard on segment reporting. Segment information disclosed shall be prepared in conformity with the accounting policies adopted for preparing general purpose financial statements.

In his first visit to China as the new Chairman of the International Accounting Standards Board (IASB) during July 2011, Hans Hoogervorst commended China on the progress it had made in building an accounting profession and setting in place a process of continuous convergence with IFRS. He said that Chinese interests will be given careful consideration in IASB debates.

Although new PRC GAAP is ‘principally in line with IFRS’, China would benefit from eliminating remaining differences as the broader international financial reporting community and investors around the world better understand a company’s financial statements that
are labelled ‘in conformity with IFRSs’.

With South Africa being admitted to the Brazil, Russia, India, China and South Africa (Brics) trading block in 2011, we would expect even more mutually beneficial business ventures between South Africa and China in the future. ❐

Author: Angie Ah Kun CA(SA) is Senior Manager, Technical Department, KPMG


Investing with HIM VS her?

Investing is historically a male-dominated industry; therefore it’s logical that there are significantly more male fund managers than female fund managers. Yet statistically, female and male fund managers approach decision-making differently. But how does this affect the return I earn? If I’m comparing the results of two funds which are both managed by men, I’m not really allowing for any differentiation, am I?

So why this fascination with gender in investing?
It all started when I was doing some research on the internet to assist me in how I personally invest. I found a simple questionnaire that I could answer to assist in deciding how to allocate my money, which for a while let me think I’d discovered the pot of gold at the end of the investment rainbow. I like questionnaires – they’re objective and have helped me determine which ‘Friends’ and ‘Sex and the City’ character I was in the past… so I proceeded to answer the questions…
It seemed to be a personality test, assessing how much risk I was willing to take; whether I could handle a crash in the market and what my investment horizon was. At the end I was given the following result:

If you are male: Allocate 100% of your investment to equity.

If you are female: Allocate 70% of your investment to equity and 30% to money market.

What! Why was I being given different advice because I’m female?
So this is where this story really begins. The reason I was ‘classified’ differently based on my gender is because of certain behavioural biases known to affect the way people invest – which manifests differently in men and women.

The most notable of these behavioural biases is ‘risk-aversion’. We all know that a person’s propensity to take on risk is a significant determining factor of their investment behaviour. Men were found to make larger investments and buy riskier stock than women, who are statistically more conservative. Why this risk-aversion from women? Well, it’s been said that from a biologically-based, evolutionary point of view, women are required to be risk-averse. Being mothers, the survival of the human race is dependent upon their ability to give birth and protect their young, which requires an element of conservatism. Men, on the other hand, need to take risks to go out and ‘hunt’ that perfect mate. Men tend to interpret a risky situation as a challenge and want to engage, spurred by their egos. Women, on the other hand, tend to interpret the same situation as a threat and be more averse to competition.

Men also have the propensity to be more overtly confident in their knowledge and investing ability, akin to the caveman days when men were required to confidently go out and hunt, thereby providing for their families. Men generally rate their own capabilities higher than women do, even though, there is little actual difference between men and women in conventional intelligence, i.e. IQ. Furthermore, men often exhibit an interesting phenomenon, known as the ‘self-attribution bias’. When they perform a task well, they attribute it to their skill – but when they perform a task poorly, they’re more inclined to say they were unlucky. Women, on the other hand, exhibit a ‘negative recall bias’, whereby they tend to remember their poor performance, which then negatively affects their belief in their own competence going forward.

So how does this all affect the way men and women invest? Well, men, being more confident than women, due to stronger belief in their own competence and the self-attribution bias, will accept more risk and trade more often than women do.

In a study performed by Barber and Odean (2001), they found that men trade 45% more than women. Being ‘overconfident’, men were found to trade more than the ‘rational’ trader, which reduced their expected utility.

So, does all this also apply to us in South Africa?
To answer this question, an undisclosed investment house was kind enough to give me some data which calculated the internal rate of return (IRR) earned by 11 000 individual investors over different time periods from 1 January 2007 to 31 December 2011.
Correlating investor return to trading frequency, I was able to confirm that over-trading does lower investor return. This phenomenon is attributable to friction and the effects of mistimed trades. Investors should rather buy-and-hold than trade vigorously to maximise their returns.

Furthermore, it was found that men trade more than women.
So now what about the actual return? Interestingly enough, no differential was found in the return earned by men or women over any of the periods analysed. However, an interesting observation was noted on the variability of return earned: Men were found to
have significantly higher variability in their return!

So, let’s make this practical. You have the choice of giving your money to Bob or Sally. Both Bob and Sally will most likely earn you a return of 5%. Having your money with Bob, your return could be anywhere between -5% and 15%, but most likely 5%. Having your money with Sally, your return could be anywhere between 3% and 8%, but most likely 5%. No difference in the absolute return, but on a risk-adjusted basis, you’re ‘safer’ with Sally.

This begs the question: “Shouldn’t there be more Sallys than Bobs in the investment world?” If your money is safer with conservative, risk-averse Sally than slightly overconfident Bob, surely we should be encouraging the training and support of more women in the profession? And putting our money into the careful, considered hands of a female fund manager? But I might just be saying that because I’m a woman… ❐

Author: Gizelle Willows CA(SA), MCom (Finance), is a lecturer at the University of Cape Town.
The folly of ‘breaking’ Trusts.

While recently analysing a trust deed for a client, I started wondering why so many individuals who use trusts in their estate planning – and their advisors – are so intent on ‘breaking’ their trusts? Why would a planner go to the trouble of creating a trust, the expense and effort of transferring assets to a trust and of administering a trust – to then deprive him or her of the benefits offered by this versatile estate planning tool? The answer, it would seem, is the result of forgetting why the trust was created in the first place, while not understanding the concept of having a vested right in trust assets.
Let us begin by looking at why clients typically decide to create a trust. Speak to an advisor regarding trusts and they’ll usually tell you about its many advantages. Trusts, we are told, can be used to reduce income tax, postpone capital gains tax and save on estate duty. It can also be a means for safeguarding assets from attachment by creditors and preventing these from falling into the hands of spouses during divorce proceedings. These last two are the reasons most often given by my clients – including the one mentioned at the beginning of this article – for using trusts as estate planning tools.
An ‘inter vivos trust’ can be either a discretionary trust or a vesting trust. In this article we deal mainly with discretionary trusts. Let us now look at the concept of a ‘vested right’ as it pertains to trust assets.

1) According to the case of Jewish Colonial Trust v Estate Nathan1, a right can be said to vest in a person when he/she owns it. Secondly, the case tells us, the word ‘vested’ can be used to draw a distinction between: “what is certain and what is conditional: a vested right is distinguished from a contingent or conditional right”.

2) The case of Goliath v Estate Goliath2 points out another interesting aspect of vested rights, namely that the right is ‘immediate’, but ‘the enjoyment thereof may be postponed’. A right can be said to be immediate if it is not dependant on any further contingency, such as the survival of the beneficiary to a given age or the death of a given person3.

3) It is also clear, from the case of Jowell v Bramwell Jones4, that once a right is vested in this sense, it is transmissible to the successors of the beneficiary on death or insolvency and it forms an asset in the beneficiary’s estate. A contingent right on the other hand does not form an asset in the beneficiary’s estate at death.

I see trusts ‘broken’ most often due to a common trust bookkeeping practice that is often recommended to clients. Briefly, this involves the allocation in the trust’s accounts of a certain portion of the trust’s income or capital gains to a specific beneficiary, and then crediting the amount to that beneficiary on loan account. In this instance the income or capital gain is said to be allocated to beneficiary ‘X’, but the money is not actually paid and a loan account is created in beneficiary X’s favour in the trust books, while the trustees still administer those amounts on that beneficiary’s behalf.
This is done to reduce the trust’s liability for income tax and capital gains tax by means of the conduit pipe effect created by section 25B(2)5 and Paragraph 80(2)6. These sections allow trust income or capital gains to be taxed in the hands of a beneficiary at that beneficiary’s marginal rate of tax, as opposed to the trust’s flat rate of 40%. However, this will be the case only if the allocation is done within the tax year in which it accrued to the trust. In this way the trust acts merely as a conduit pipe, in that the trust income or capital gains flow through it to the relevant beneficiaries.
At first glance this practice may seem beneficial, as it could give rise to a tax saving. However, the allocation of a trust asset or of income or a capital gain to a beneficiary has serious consequences of which advisors and their clients often lose sight in their eagerness for tax savings. This is the case even if the date of delivery is entirely at the discretion of the trustees.
Such allocations, as shown earlier in this article, create vested interests in favour of specific beneficiaries and as such exposes the assets to:
estate duty in the estate of that beneficiary
executor fees in the estate of that beneficiary
potential attachment by spouses or creditors of that beneficiary.

These are exactly the negative consequences the trust planners were trying to avoid!

It should also be borne in mind that there will always come a time when such amounts will in fact have to be paid out, either to the beneficiary or the beneficiary’s estate. Keep in mind also that trustees are obligated to at all times have sufficient assets in trust to settle all such claims. Their failure to do so could lead to personal liability on their part. It must also be mentioned that clients and their advisors often attempt to circumvent these negative effects by including all manner of clauses in their trust documents purporting to say that these assets are excluded from attachment until such time as the assets have been paid over to the relevant beneficiary, and that should the beneficiary be declared insolvent prior to receipt of such assets, that the asset will revert to the trust. Such attempts or pretences contained in a trust deed are usually a ‘nudum praeceptum’ or ‘nude prohibition’ and therefore invalid, as shown in the well-known cases of Vorster v Steyn7 and Du Plessis v Pienaar8.
Cameron et al, in Honoré’s South African Law of Trusts explains as follows:
“When a testator gives someone the ownership of property or an immediate right to the corpus or capital of an estate or fund the testator cannot then impose restrictions on the use of the property by the heir or legatee or in any other way impair his freedom unless this is done in the interest of a person or persons other than the beneficiary or for a defined impersonal object… A restriction imposed purely in the interests of a beneficiary who is in the above sense owner does not bind the beneficiary and is termed a nude prohibition (nudum praeceptum). If the testator purports to impose such a prohibition by way of trust, the trust is not in general invalid, since there is a beneficiary, but the latter is not bound by it and may insist on administering the property to the exclusion of the trustee, as may his trustee in insolvency.”9

I therefore suggest that any trustees and their advisors, when tempted to allocate trust income or capital gains to beneficiaries for no reason other than to reduce the tax liability resulting from the receipt of such income or capital gain, should first think long and hard about the reasons for which the trust was originally created. Remember that the trust’s assets will repeatedly pay out estate duty and executor fees. The first instance will be upon the client’s death and repeatedly thereafter in the estates of heirs as they in turn pass on and leave the assets to their own heirs. As long as the income and capital gains are kept solely in the trust, these will not be liable for estate duty and executor’s fees in the hands of a nominal individual and the savings on estate duty and executor fees can keep repeating through the generations. The same principle applies to allocating other trust assets besides the income or capital gain.

I am of the opinion that, if you consider the potential savings through the generations and also the protection that trust assets enjoy from creditors, a short term tax saving by allocating and vesting assets to individuals does not justify depriving the beneficiaries of the protection that the trust has to offer. Trustees and advisors should guard against losing sight of the objectives of the trust and take care not to deprive the authentic beneficiaries of this protection. ❐
For references visit www.accountancysa.org.za

Author: Franscois van Gijsen, CFP®, BProc; LLM (Tax Law); Dip. Legal Practice; Post Grad Dip. Financial Planning; Adv Post Grad Dip. Financial Planning is Director Legal Services at Finlac Risk and Legal Management.


Assurance implications for sustainability reports

It is widely acknowledged that the market places a premium on companies that demonstrate sustainability. A need has thus arisen to obtain assurance over the representations made by management in sustainability reports – in much the same way that the market requires assurance on the financial information in companies’ annual reports.

Assurance can increase the credibility of representations made by management, which is critical to the functioning of capital markets. When sustainability reports have been assured, stakeholders can place a level of reliance thereon and feel comforted that they are making decisions based on valid, accurate and complete information that has been prepared in accordance with the chosen sustainability reporting guidelines.

Assurance of sustainability reports is being driven by various stakeholders as well as specific reporting guidelines and corporate governance codes and best practice. Locally, these include King III, which states that sustainability reporting and disclosure should be independently assured, and the Global Reporting Initiative (GRI) G3 Guidelines, which require an organisation to disclose the policy and current practice for seeking external assurance. This is because there are many benefits to assurance including:
• Improved quality – the rigour of an assurance process can identify weaknesses and gaps which may otherwise be missed
• Improved credibility – having information externally assured lends credibility to the information
• Improved reliability – the process can protect the company from the risk of publishing inaccurate information, statements and claims.

One of the first questions organisations need to consider before embarking on their sustainability assurance journey is: who should provide this assurance? Unfortunately, there is no one-size-fits all answer. The assurance provider will depend on the nature of the organisation and stakeholder needs, as well as the information to be assured. In practice, assurance is being provided by:
• Specialist auditing or compliance bodies – an option mostly used when there is detailed technical information for which specialised knowledge is required
• Financial statement external auditor – which is becoming more common as organisations adopt the principle of integrated reporting
• Other external auditor – favoured by organisations that prefer to have different independent parties providing assurance over different aspects of their reporting.

Regardless of the assurance provider(s) selected, an organisation should ensure co-ordination among them to avoid duplication, minimise gaps and keep costs to a minimum.

Domestically, the preference in the market is for organisations to use the same external audit firm responsible for assuring the organisation’s financial statements to also provide assurance over their sustainability report. This is especially so in light of the move towards integrated reporting.

The next question an organisation needs to consider is the scope of assurance to be provided. There is no legal requirement in South Africa to have sustainability reports assured. Hence, there are no legal requirements defining the scope of assurance – which is why ‘new territories’ are being charted in this space every day.

What has been seen in practice is that specific quantitative and/or qualitative aspects of sustainability reports are being assured – for example, specific data points and/or GRI G3 application levels and principles etc.

When defining the scope of assurance, it is important that suitable criteria are available. This is because one of the fundamental requirements for obtaining assurance is that there should be suitable criteria against which the subject matter can be assured. Criteria can be formal or informal, and can either be defined by management or a globally accepted standard.
Suitable criteria will have the following characteristics:
• Relevance – the criteria will assist stakeholders in formulating a conclusion
• Completeness – the criteria will be sufficiently complete when relevant factors that could affect the conclusions drawn by stakeholders are not omitted
• Reliability – the criteria will be reliable when they allow reasonably consistent evaluation or measurement of the data and/or information
• Neutrality – the criteria will be neutral when they will result in stakeholders making conclusions that are free from bias
• Understandability – the criteria allow stakeholders to make conclusions that are clear, comprehensive and not subject to significantly different interpretations.

To enable stakeholders to truly understand the scope of the assurance engagement (that is, what is being assured) and the results, the criteria need to be made available to them.

After determining the scope of the assurance and the relevant criteria, the standard which will be applied by the selected assurance provider should be determined. Globally, two standards for sustainability assurance are widely used:
AccountAbility’s AA1000 Assurance Standard (AA1000AS)

The International Accounting and Auditing Standard Board’s International Standard on Assurance Engagements: Assurance engagements other than audits or reviews of historical financial information (ISAE3000).

Regardless of the assurance standard applied, the assurance provider will not be able to provide absolute assurance because of the following inherent limitations associated with assurance:
• The use of selective testing – ie, the testing of samples
• The limitations of internal control
• Much of the evidence available to the practitioner is persuasive rather than conclusive
• The use of personal judgment in gathering and evaluating evidence
• The characteristics of the subject matter.

The outcome of an assurance engagement is the assurance statement, which provides the assurance provider’s conclusion on the data, information, principles and/or report included in the scope of assurance. Its form and content may differ depending on who the assurance provider is, the assurance standard applied, the level of assurance, the scope of assurance, the work performed and the results.

It should be remembered that sustainability assurance is a journey and one for which companies should carefully consider the various matters raised above before embarking thereon. ❐

Author: Kelly Gilman CA(SA) is Senior Manager: Climate Change and Sustainability Services at Ernst & Young. This article is an extract from Green II published by the South African Institute of Chartered Accountants and Juta.