Lessons from the Scandal: Three Weaknesses of IFRS – The Wirecard Story so far (5)
The Wirecard case provides a lot of lessons for analysts and investors. However, one aspect has not been discussed a lot so far. The question: Did all this happen despite our well-functioning accounting and reporting system? Or did IFRS rather push the Wirecard developments?
It turns out the truth is somewhere between the extremes. This is discussed in this blog post where we shed light on three issues that – while certainly not being the root of all evil – at least supported the way the Wirecard story developped over time: cash, goodwill accounting, and revenue recognition.
The different Faces of Cash
The cash position on the balance sheet is a very tricky one in general. It is in most cases disclosed more or less as one single number (with some minor restrictions to this) – but from an economic point of view it rather has totally different faces. Not all cash is equally well accessible. Sometimes cash sits in the direct cash account of the reporting company (best accessible) but often at least parts of the cash are somehow – in a soft or a hard way – restricted: some cash sits in subsidiaries and takes time to be streamed up to the mother company, some cash sits in countries with repartriation issues, some cash is used as a collateral for some sort of transactions, and so on and so on (much more on this restricted cash problem can be found in one of our former blog posts HERE)
In the case of Wirecard, a part of the cash should have been in escrow accounts in order to back the insurance-like services of the German company (more on the original business model of Wirecard can be found HERE). However, over the years it was absolutely unclear how much. This possibility for intransparent disclosure helped Wirecard to mask the fact that quite a lot of this cash was unaccessible.
Unaccessible is admittedly a euphemism here: In the end it was clear that the cash is not locked in escrow accounts but rather not existent at all. However, if a more detailed split-disclosure had been mandatory for cash, analysts and investors would at least have seen which part of the cash is directly available for use (non-restricted) and hence would have had a much clearer picture of the liquidity situation of the company.
And Wirecard is not alone: As long as there is no solution on how to disclose a split-down of the cash account we will always have to live with the hard surprises – in particular for companies that are already in trouble – of some cash not being accessible when needed. The sheer materiality of this aspect combined with the not too tricky implementation of a split-down disclosure should clearly be a wake-up call for standard setters to make this balance sheet position more transparent.
Goodwill Impairment – The Headroom2 Problem
While the whole goodwill impairment accounting topic always attracts a lot of different critique, we want to focus on one particular point here: The headroom2 problem and the possibilities for companies to shield the goodwill of acquisitions from future impairments. We have explained the functioning of this technique in detail in one of our former blog post HERE.
Starting point of this technique is the fact that a goodwill impairment testing does NOT necessarily test the goodwill of a former acquisition for potential impairment, but rather tests the cash-generating unit (CGU) to which this goodwill has been transfered after the deal for potential impairment. The trick is now to bring a unit which is running risk of being impaired (CGU 1 in the graph below) into a larger unit which is far from any impairment risk (i.e. which has a lot of headroom, CGU2). Then the newly combined unit (CGU 3) certainly has less headroom but still enough to not being impaired.
Wirecard has very successfully played this headroom2 game. In 2015, Wirecard bought the payment activities of the Great India Retail company (mainly the Indian company Hermes I Ticket Pte. Ltd. and Star Global Currency Exchange Pte. Ltd.) for a price of roughly 314 mio Euros from an investment vehicle. As it turned out, the company has been bought only shortly before by this investment vehicle for only 35 mio Euros. The full circumstances of this deal are still in the dark. In particular, we do not know so far who the economic beneficiaries of the investment vehicle are.
Whatever these circumstances are, however, the acquired companies were fully consolidated in Wirecard’s group accounts with effect from 30 December 2015, and during the purchase price allocation (PPA) process a lot of goodwill was uncovered.