re: accounting for dummies�lessons from... cont-:Lesson No...

re: accounting for dummies�lessons from... cont-:

Lesson No 4.

Examine the makeup of the earnings. Are they sustainable? From operations? Or book entries?

Even if perfectly valid, a profitable business whose profits derive solely from book entries is likely to struggle if operating cash flow is inadequate.

FEA never made any profits from sawmilling, only MISs.

In Gunns? case, with the decline of new MISs and woodchipping, its profits are increasingly made up with book entries.

FT makes virtually nothing from operations, any fluctuations in net profit result from movements in the book value of standing timber.

Lesson No 5.

Beware of one off book profits used to boost earnings.

Stated earnings often include one off items, like asset sales. Profits can be boosted if an amount in excess of the book value is received. Sometimes it?s an artificial boost as the book value can be the subject to a little creativity.

In the 2008 year Gunns? took over Auspine and related entities. Included was 33,000 hectares of radiata, which were almost immediately put up for resale. The book value of the trees acquired was such that when sold for $173 million, a profit of $23 million was booked. The acquisition price of assets acquired as part of the Auspine deal was subject to ?fair value adjustments? at the time they were recorded in Gunns? books.

The question is whether the ?fair value adjustments? were fair?

Lesson No 6.

Beware of profits boosted by a ?discount on acquisition?

If a company pays less for a takeover company, than its claimed value, the difference is included as part of profits. When Gunns acquired ITC Timber from Elders recently, it paid $88 million for assets with a book value of $91 million and immediately booked the $3 million discount on acquisition as profit.

The book values recorded in the acquirer?s books are subject to fair value adjustment. Gunns wrote back $11 million in assets, mainly inventory, at the time of the ITC takeover, but the total value still exceeded the purchase price. If that hadn?t occurred the discount on acquisition would have been $14 million. Might have looked a bit too obvious. It certainly would have helped the full year 2010 results. Too late to change?