I is for Ireland

“Leprechaun economics” is the term Nobel-prize winning economist Paul Krugman used. With all due respect to Ireland–that greenest land of wind, stories, and music to soothe the soul–their tax law sucks bilgewater.

Leprechaun economics, picture at ginokenny.com.

The Republic of Ireland has managed, in the last fifty years, to transform itself into the world’s largest tax haven. Meaning a place that allows multinational corporations, particularly those formed and operating in the U.S., to use creative accounting to pay very little in taxes. How little? How about 0.005%?

Apple Chooses Between Single Malt or Double Irish

Apple is a company that has always thought far in advance about packaging and design–including on their financial statements. Back in 1980, about the time when they were prototyping the Macintosh, Apple opened a small office in Cork, Ireland, lured by a deal to pay no taxes for several years. Such local tax arrangements aren’t that unusual–Twitter moved into a derelict building in downtown San Francisco for the same “no tax for years” deal, while Delaware has long been known as a favorable legal and financial place for companies to incorporate.

What Apple was also able to do, over decades, was use its growing economic power to support an Irish shift into a myriad of favorable tax strategies–favorable to corporations, that is. A so-called Base Erosion and Profit Shifting (BEPS) plan allows companies to put their huge patents as giant assets on their balance sheets, in Irish subsidiaries. These patents, the stock and trade for tech companies, are amortized (charged out over time) in a convoluted way that allows the income received to be located in Ireland–with very low tax rates–even if it was earned somewhere else.

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H is for Hedge

“Greed is good,” trader and arbitrageur Ivan Boesky told our MBA class of 1984. He arrived with a stretch limo and an entourage, wearing a fur coat and an expensive Italian suit. He explained that his job was to find opportunities that others missed and that the trade-off in risk and reward was real. Those willing to accept more risk–the risk of losing money because a ship sinks or a drug fails–should get the bigger payout when the exotic cargo comes into port or the cure for disease proves successful.

The risk part is the problem. How can you minimize the risk and still receive high enough payouts to cover costs? Entourages aren’t cheap. One answer is a hedge fund.

English hedge maze. Photo at atlasobscura.com.
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G is for GAAP

GAAP illustration design from Oracle Netsuite marketing site.

GAAP. FASB. AICPA. APB. If you studied accounting formally, the first few pages of your textbook typically listed a set of acronyms that would make your eyelids flutter. The Financial Accounting Standards Board, the American Institute of CPAs, the Accounting Principles Board, etc. Buncha old (white) guys doing boring talking, as my son used to describe it. Except that what these guys do (and a handful of gals*) is remarkable. Because they set the standards for every other company in the United States.

GAAP stands for Generally Accepted Accounting Principles, and it’s the prodigious set of rules that dictate how businesses should report their financial results. FASB is an independent group, elected from the community of practicing accountants. That means accountants are part of a guild.

G is also for Guild

If you remember your history of guilds, they arose in the Middle Ages as artisans developed their crafts and wanted to set their product standards. Rules were developed for certification to become part of the guild, and the guild stamp of approval reflected its authenticity and craftsmanship.

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F is for Fraud

Design from si.interactive.com.

Enough of the accounting philosophy, let’s talk about something more fun. Fraud!

If accounting is as old as the hills, so is fraud. If you recall my post about Clay Balls a few days ago, you may remember that they were storage for tokens carried by tax collectors. The tokens were stored inside hollowed balls to “prevent tampering.” In other words, tampering–tax collectors collecting a few of the tokens to barter for their own purposes–was already a common practice in 3000 B.C.E. Where there are tax collectors, there are corrupt tax collectors, apparently.

Oops! My Warehouse Burned Down…Insurance Fraud

There was also ancient insurance, and with that came ancient insurance fraud. Ancient merchants purchased “bottomry” contracts (now there’s a word!) in Babylon as early as the third millennium BCE, as did Hindus, Greeks, and others. A trader would get a loan for his cargo and pay an extra fee for insurance, with the interest on the loan also helping cover the loss. When the ship came in, if he defaulted on the loan, the insurer would keep the cargo.

Design from antikytheramechanism.com.

The Greek merchant Hegestratos decided to try an end run around his bottomry contract, in 360 BCE. He had received a cash advance and figured to keep it–and the corn–and claim an insurance loss. He put the corn in secret storage and sailed the ship, but empty. However, there were other passengers on the ship, and they were not too keen when they noticed him trying to scuttle the empty vessel. They chased him off, and he drowned. So much for early insurance fraud!

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E is for Earnings

While we look for harmonious balance, we are also creatures of change and achievement. We yearn also to count. Any youngster who approaches a pond with pebbles will toss them in and count the skips or try to hit the lily pad ten times. Or a crew rows by us on the river and we count the strokes. Well, maybe I just do because I was raised on Sesame Street. Remember The Count? Vun…doo…tree bats… ah.ah.ahh…

The river of time flows by, but we are compelled to stop and take reckoning every so and often, after a month, the year. What comes in, what goes out? Are we draining our resources or building a surplus?

Drawing by Leonardo Da Vinci, “study of water passing and falling,” shown in kensycooperrider.com.

That’s the purpose of an Income Statement.

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