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Accounting Consumer
Behavior Economics Finance
Management
Human values in organizations
Development of Financial Market and Accounting
Regulations in Ukraine
Research of Ukrainian financial market and accounting
regulations requires a great deal of intellectual efforts
and personal experience. At first glance, financial market
may seem not existing at all, and accounting looks like something
confusing and undeveloped. Yet, each of them reflects current
economical, political, social situation and serves specific
goals, ranging from tax collecting to acquiring of enterprises.
I would like to divide national financial market into two
components: banking sector, or market for monetary resources
and capital market. Interrelated in all developed countries,
they are almost independent in Ukraine. It means that banks
may buy or sell securities, but it’s a minor activity for
them; banks may finance some traders, but these are ordinary
transactions with total volume 4 times less than that in industry
or agriculture. The reason for this is in the sources of profit
from business operations. While activities of banking system
do not differs significantly from those anywhere in the world,
capital market acts mainly as a registrar of deals.
Banking is a two-level system, with National bank, which
ensures stability of monetary policy in the country and commercial
banks, directly engaged in financing of economy. International
experience proves, that national bank should be independent
of political authority, however in Ukraine this do not take
place. From its first days, National bank served as a tool
for improving negative consequences of economic experiments
of Government. As a result, inflation rate reached level of
400% in a few past years and remains 10-15% annually. Only
recently, budgetary and monetary policies were separated and
National bank received an opportunity to make weighted decisions.
Commercial banks, which are supposed to invest in economics,
offer their credit services mainly at short term basis; often,
however, under pressure of Government, these terms may be
increased significantly, up to indefinite periods in future.
Recent bankruptcy of the largest bank “Ukraine” is a confirmation
for this. It had the widest network in the country and reputation,
comparable with that, for example, of Deutche Bank in Germany.
Nevertheless, a few hundreds of millions of dollars of unsecured
credits undermined its financial performance and made this
bank out of the market. Banking system develops mainly due
to services, provided to corporate clients: everyday business
transactions, deposits, currency exchange, etc. Private savings
are reported as constantly increasing, but their amount is
still low in comparison with that in business services. Another
side of activities of commercial banks is their direct participation
in agricultural and industrial enterprises. For example, cultivation
of corn is both highly profitable and risky business, which
needs adequate investments; unfortunately, many farmers still
cannot finance it. Traditional bank loans are not applicable,
because of high interest rates; futures contracts do not take
place, because of high risks; the only choice is to assure
investor in a good return. So, banks finance agricultural
farms, but their managers directly participate in all phases
of production: up to the delivering of corn to elevator. This
practice would dramatically change the overall picture of
Ukrainian economy. First of all, it can not be reported as
a kind of the bank services, because financing is provided
on the basis of future benefits, but not on the basis of thorough
analysis of client’s business plan and credit status. At the
same time, banks do not attempt to acquire a particular company,
because its business has nothing to do with bank’s, although
specific projects, if properly financed, seem to be perspective.
This practice results in increasing of economic growth at
selected enterprises and in additional sources of extra profit
for a bank. Such cooperation is still not a financial group,
but it is going to be a basis for it. Moreover, it is a component
of active bank’s participation in a capital market.
The capital market in Ukraine emerged in early 1990s. Since
then, it remains very small in terms of number of transactions
and volume of total transactions. Only $650 million traded
during the period from first to third quarters of 2001. Industry
experts view the market as “having the necessary infrastructure,
but lacking transparency and enforcement of the corresponding
laws.” At my opinion, market lacks also objects of trade,
i.e. profitable companies and subjects of trade, i.e. buyers.
It was three distinct stages of the capital market’s development
in Ukraine:
1. The market of issuers (1991-1994)
The issuers issued, sold, and bought their own securities.
This led to natural (and specifically engineered) trade schemes.
The customer awareness of the market was minimal. The result
was virtually all joint stock companies, created in 1991-1994,
bankrupted, leaving thousands of private investors without
any return.
2. Initial stage (1995-1997)
In this period, investors realized that money lost between
1991 and 1994 would not be regained. The government created
the Securities Stock and Exchange Commission to oversee securities
transactions. This small-size market was dominated by public
venture firms, heavily relying on financial inflows from offering
securities to the public. Unfortunately, virtually all stock
owners of these venture firms lost their invested money. Naturally,
during the period of 1991 – 1997, small (middle class) investors
lost confidence and left the market.
3. Regulated market (1997-present)
During this stage, the state tightened control over market
participants. The State Securities and Stock Exchange Commission
provided basic regulations governing transactions between
market participants. At the same time, regulation of companies
issuing securities was not enough strong to provide for a
transparent market. In 1994-1997 during the period of “mass
privatization” (when privatization certificates were distributed
to the citizens free of charge, for further exchange for stocks),
mutual investment institutions appeared and played the premiere
role in soliciting privatization certificates from the population.
Resulting cash outflow was almost invisible and majority of
these institutions disappeared forever. Other, according to
the State Securities and Stock Exchange Commission, “were
transformed into new kinds of mutual investment institutions,
providing better protection of private investors.”
The largest meeting place of buyers and sellers is PFTS
Stock Trading System in Kiev, with total trading volume $
300 millions this year and average number of trades 30 per
day.
Capital market can be divided in two following sectors:
The Market of Corporate Stocks
According to the State Securities and Stock Exchange Commission,
in October 2001, there is 38,500 joint stock companies, including
12,300 open joint stock companies, the total amount of stock
issues were $ 6.3 billion. However, this figure does not represent
the capitalization of the market, since only a fraction of
these stocks are traded or, at least, in demand. During the
first three quarters of 2001, a total of $ 1,3 billion worth
of stock was issued. Of this, only 24 percent represented
real financial inflows (the other 76 percent represents re-registration
of existing entities.)
Government Bonds, T-Bills, municipal Bonds
After the crisis of 1998, municipal bonds are not actively
traded on the market. Only a couple of cities, tourist centers
on a seaside issued them for improving the local infrastructure:
hotels, beaches, roads. Government securities are traded mainly
between government agencies and large companies, they also
may be used by buyers for tax purposes. For example, commercial
bank decided to buy a certain quantity of T-Bills, but because
profitability did not exceed real inflation rate, bank instead
of trying to sell, might use them to pay taxes. Recent tendencies
shows that this type of securities becoming more and more
popular: two debuting sessions resulted in $40 millions of
sales.
General analysis of Ukrainian capital market shows paradoxical
results: while state attempts to follow American model, attracting
private investors, de-facto market is completely closed and
tries to reach German/Japan model. The reason for this is
not close relations among subjects and objects of the market,
but unwillingness of owners to disclose and sell stock to
the public because of fear of losing “control” over the company.
As it happens, all profitable enterprises were acquired, partially,
or completely, illegally and competition with potential investor,
whether it could be small national or a large west investment
fund, may lead to the change of ownership. On the other hand,
no government law can force an individual to buy stock without
any perspective to gain a profit, as it take place with majority
of traded on market securities. Nominally, all of them are
Growing, because no issuer promises to pay a dividend, and
income is expected only from difference between present and
future prices. But because almost all deals are also nominal,
changes in prices and changes in stock indexes can not be
taken seriously. What does it mean “nominal deal” ? Stock
market is not abstract, but concrete place, where people earn
money from margin. But, because availability of profitable
or growing stocks is small, prices of junk stocks have been
increasing artificially: traders sell them to one another
imitating investing activities and waiting for real outside
buyer. In addition, PFTS Stock Trading System’s officials
are also interested in such an imitation, because it creates
an image of working and profitable system.
Among other problems, Ukrainian capital market faces with,
industry specialists distinguish:
1. “Flawed investment climate” and the high risk of investing.
2. Unfinished privatization in many joint stock companies
that delude potential investors. (The total charter capital
of privatized companies, with at least 70 percent of a company
privatized, is 14 percent of the total charter capital of
all companies.)
3. “Lack of domestic investment funds, that is, the absence
of cash among most citizens.”
Recommendations how to solve the above mentioned problems
can be found in any book on economics; simply, they can be
described as “make it different”: improve investment climate,
finish privatization… Unfortunately, these banal recommendations
require complex scientific approach and hard work, they conflict
with interests of many political and economic groups; most
likely, they will be dissolved in numerous laws and decrees.
In addition, from historical experience, any change should
be simple and crucial, like revolution in Russia.
I would like to discuss the most important and easiest to
implement solution: to create transparent and effective technology
of ownership. Companies must have market value and buyers
should pay for it, no more and no less. In general, on capital
market, this action does not differ from that on any other
markets; the only thing to do in Ukraine is to establish rigid
rules how to became an owner: how to evaluate an assets, how
to issue stock, how to sell, how to register a deal. Still,
legislation is approved for a marketplace itself, but not
for traders and objects of trade. Could you imagine a customer
who knows everything about planning, supply chain, management
of the nearest supermarket but have no idea how to buy food
there ? Moreover, that food could be sold at different prices,
depending on personal decision of management.
For example, highly profitable and largest Ukrainian and
European manufacturer of tires “Rosava” was sold for a book
price of $ 400 millions, market price, however was, at least
$ 2 billions; results were announced 4 days after the deal;
deal was proven to be legal. If such deals like this will
appear again, Ukrainian capital market would play the role
in future, it plays now: just legally approved place for registration
of ownership. It means, that first reason why companies come
into capital market in Ukraine is to register changes in ownership,
because according to civil law it should be done there: on
PFTS Stock Exchange, on local exchanges. But without the exact
knowledge how these changes were made, this registration is
useless, moreover, it undermines the image of the capital
market as a whole.
Transparent ownership legislation will make possible to
determine strategy of developing of the capital market, to
evaluate which model exists or must exist in Ukraine. Whether
we should continue attracting small shareholders, thereby
attempting to stimulate cash flow from personal savings into
industries (USA model of capital market), or preference should
be given to financial groups, as it takes place in Germany
or Japan. The structure of ownership will show whether sources
of company’s financing are public or not, whether it would
borrow from stockholders or somewhere else.
Second role, the Ukrainian capital market could play, is
to be the marketplace for international companies willing
to buy stocks in relatively cheap local firms. Although this
role requires much broader and separate discussion about investment
climate in Ukraine, importance of such marketplace is difficult
to underestimate.
A foreign investor contemplating doing business in Ukraine
should anticipate a legal and regulatory framework that extends
into each area of activity or endeavor. A notable characteristic
of this framework is characterized by two features. The first
feature is that Ukraine's laws, particularly in the commercial
sector, are still in a relative state of flux. This means
that changes to laws and regulations occur on a very frequent
basis. The second feature is that, as a result of this state
of flux, there is often conflict between (and even within)
different laws, regulations, decrees, etc. Such conflict and
inconsistencies can also be experienced in Western countries,
but with far less frequency. As a result of the conflicts
that are generally inherent in the Ukrainian legal framework,
precise and definitive interpretation of a particular point
or legal concern can often be difficult to obtain.
Traditionally, Ukraine was always described as a country
with a "code-based" legal system that is generally
found in continental Europe (in contrast to a common law-based
legal system found in the UK, Canada and the USA). Many experts
also describe it as being close to Latin-American legal system.
Unfortunately, these seemingly comfortable descriptions fail
to reflect the real situation where Ukraine's legislation
consists of several relatively stable codes and numerous laws
and regulations. Certain areas, like Accounting Regulations,
are particularly prone to inconsistencies and conflicting
provisions, appearing with increasing frequency since 90-s.
The reason for this is inability of Government to provide
sound economic politics and its desire to create conditions,
under which collection of taxes and penalties would be easiest
and most effective. In addition, total number of institutions,
engaged in all those kinds of activities, which can be described
as tax/penalty collection, exceeded that of party and state
organizations under communism. Accounting became the most
unstable, most confusing, and even most expensive part of
business; thousands of employee waste working time, studying
new standards, laws and decrees. However, tactically, this
Governmental approach is perfect, because it fills state budget
and feeds, for example, millions of pensioners or 40% of population.
The newest example, illustrating state fiscal policy, is
a procedure of adoption of International Accounting Standards
this year. Theoretically, this would enable companies to cut
financial statements preparation costs, especially in case
of consolidating financial statements of enterprises that
have operations in different countries. But in practice, this
led only to mechanical changes in names and quantity of accounts;
inconsistency between Ukrainian and international standards
remained on the same level. Enterprises, however, spent giant
sums of money, training employees at state educational centers,
buying new literature, paying penalties and losing productive
time.
Main differences between Ukrainian and International Accounting
Standards.
Low-Value Assets
Until now the Ukrainian accounting standard on inventories
includes the term “low-value assets” (it may be some objects
of furniture and fixtures, computer equipment, instruments
and so on). In spite of the fact that their useful lives may
equal several years (3, 5 or even more), their value may be
written off in accordance with the entity’s accounting policy,
for example, at the moment of putting them in production.
It may seem ridiculous, but the IAS balance sheet may include
a rather large amount of fixed assets while the Ukrainian
balance sheet may include a very small amount or even nothing.
This is because of the significant accumulated depreciation
and immediate expensing of low-value assets. Initial value
of low-value assets cannot be revalued and so they can’t be
impaired.
Asset Measurement
According to Ukrainian accounting principles, assets should
initially be measured at their cost, that is on historical
basis. Their historical measurement can’t be changed except
for the following: capitalizing of subsequent expenditures
for property, plant and equipment or diminishing their initial
value in a case when part of the equipment is put out of use.
Until now there is no special standard on intangible assets,
they could not be revalued, their amortization could not be
changed, they could not be estimated annually and there could
be no recognition of impairment of intangible assets. In addition,
fixed assets’ useful lives cannot be changed and depreciation
costs and the net book value are formed on the basis of their
useful lives, as set by the Government. For example, according
to the accounting regulations, useful life for computer equipment
is equal to 10 years, but in reality it should be much lower
and this type of equipment is usually being written off faster
under IAS.
Hyperinflation and Lack of Adequate Disclosure
Being prepared on historical cost basis of accounting, Ukrainian
financial statements ignore the effect of inflation, though
the economy suffers from it; only property, plant and equipment
could (but usually would not) be revalued. As a matter of
fact, throughout the 1990s property, plant and equipment and
their depreciation were revalued several times on the basis
of adopted indexes, but without revaluation on the replacement
basis, their balance-sheet value cannot be considered as fair.
Finally, there is difference between Ukrainian accounting
standards and the IAS, concerning disclosures. Ukrainian accounting
legislation does not contain such a wide range of items requiring
disclosure of financial statements, which in turn, are very
rarely presented to the public. As it was mentioned above,
lack of transparency of ownership and financial activities
of companies is one of the most serious obstacles in developing
of the capital market in Ukraine.
Of course, analysis of national accounting principles is
impossible without brief description of taxation policy in
country. A legal entity in Ukraine is required to pay tax
at rate 30% of profit. However, income from certain activities
is subject to higher rates of taxation; e.g. income derived
from brokerage operations (40%), and lotteries, casinos and
other gaming and gambling businesses (60%).
Transactions involving the sale or realization of any goods,
labor or services in Ukraine are subject to value added tax
(VAT) at a rate of 20%. VAT is calculated and paid on the
basis of the value added at each level of production. VAT
must be remitted on the difference between the VAT received
from purchasers and that paid to suppliers and with respect
to other production costs.
Disposition of certain relatively expensive or popular items
(autos, furs, coffee, alcoholic drinks, beer, tobacco) is
subject to excise tax. In addition, an enterprise pays municipal,
industry’s (e.g., “exploitation of land resources” for mining),
special (Chernobyl, road construction) taxes at a total rate
5-15% of income. The terms “income before taxes” and “expenses”
are rigid, their calculation is standardized and penalties
for violations in calculation of taxable income generate 5%
of state budget. Financial accounting data are used primarily
for tax reporting purposes (in 93% of all legal entities)
and for the safe-keeping of assets (33%).
Tax avoidance is high and estimated 50-70% of GNP. For majority
of specialists this is one of the most important economic
problems and their recommendations are varying from decreasing
of taxes to strengthening of state control. Another statistical
data are missing, however: proportion of tax generating enterprises.
Among them, only 20% are private companies, another 80% are
legacy of Soviet economics, industrial giants, fully controllable
by Government: metal plants, refineries, food processing factories,
etc. Avoiding taxes in this field is impossible without approval
of state officials. Problem, therefore is not in high rates
or low control, but again in the lack of transparency of companies’
financial activities and ownership. Certainly, it is possible
to name other problems and their possible solutions, but all
of them are minor. Major is business itself.
For example, some people may propose decrease taxes. I am
entrepreneur and know that those who didn’t pay, wouldn’t
pay anyway, because any sum is greater then zero, especially
with the ten years’ experience of tax avoidance. So, tax collecting
should be strengthened. Yes, but it’s already rigid, additional
pressure means additional budget costs and …nothing more.
Of course, to the great extent, tax rates are important, but
the most important is possibility of doing business normally,
without perpetual conflicts with law and tax authorities.
Accounting is essential for any business, perfect (at a
given point) accounting standards create a basis for stable
and profitable work. I can’t claim, that IAS are perfect,
or they are key for solution of all economic problems. But
because successful businesses use them, it’s make no sense
to keep old or create something new (especially every quarter)
in Ukrainian accounting standards. Simple, but complete adoption
of IAS will remove artificial obstacles for companies (inconsistencies
in financial regulations), relieve working force from useless
operations (e.g., double bookkeeping of documents for financial,
VAT and tax accounting ) and create transparent business environment
(disclosure of financial statements on financial market, impossibility
to avoid taxes due to announcing of financial results, etc).
Development of financial market and accounting regulations
are two most important factors for Ukrainian economy to succeed.
While the first ensures proper financing of business, the
second is a basis for its normal functioning, and they both
suffer from instability and confusing legislation. It sounds
paradoxically, but highest economical growth in Ukraine was
reached right after the removing of ideological barriers in
economics. Just imagine: all legislation remains communist,
all accounting standards and tax regulations are still applicable
only for state enterprises, but a giant number of private
companies appear and work in this seemingly unfriendly environment.
This environment, however has a great advantage: it is stable
and predictable. And only thing to do, is to apply international
experience. Unfortunately, Ukrainian Government, still provides
communist economics politics. The core of this politics is
not in ideology, but in desire to control everything in the
country, especially cash flow. Undoubtedly, this is essential
for surviving of certain economical groups, but it’s fatal
for business. The nature of Ukrainian economy satisfies all
requirements for successful development, confirmation for
this is that economy still works and grows (since 1990, this
year is first positive growth of 2%.) The best example is
my company, which sells industrial equipment and have 14 employees.
Among those, 2 are accountants, although under Soviets or
with IAS, one would be more then enough. This is because we
should work in perpetual cooperation with state tax administration,
pension fund, state insurance company, state statistic administration,
tax police, economic police, customs, fire department, etc:
monthly, quarterly, semiannual, annual reports, audits, statements.
Minor changes in forms of financial reports and other documents
appear each month, and in order to avoid fines and penalties
accountants cooperate informing each other current news. Recent
example: changes in the form of payment order. This is a document
for monetary transaction, which remained unchanged almost
50 years. Now somebody decided to eliminate certain figure
from it and obliged all enterprises to introduce new form
in 4 days. Even such a small company as my, makes at average
6 transaction per day; upgrading accounting software means
losing, at least 4 hours of working time, money for upgrade
and business opportunities if it’s a big, dynamic company.
How, do You think, West financial market would feel in this
situation ? Nevertheless, we still work and make profit. Taxes,
experience, competition in this respect are not so important,
opportunity to work in predictable environment and to use
stable, perfect accounting standards is crucial for business
success. This will lead also to proper financing of business
(i.e. development of financial market), because removing uncertainties
in accounting regulations means also removing uncertainties
and risks in business. Banks or shareholders will know to
whom they lend money, companies will do they job, state will
help all of them and receive some reward.
Sources
1. International Center for Accounting Reform, http://www.icar.ru
2. Ernst&Young, Kiev Beacon Monthly Newsletter on Legislation,
Affecting Business in Ukraine, http://www.eycis.com
3. Deloitte&Touche, “TaxBreaks Ukraine”, weekly overview
http://www.deloitte.ru
4. USA Business services for NIS, BISNIS news and publications
about Ukraine, http://www.bisnis.doc.gov
5. Arthur Andersen, “Doing business in Ukraine”, Legal News,
http://www.arthurandersen.com/website.nsf/content/EuropeUkraineResources
6. McKinsey, “An economic Iron Curtain” http://www.mckinseyquarterly.com
7. KINTO Investments & Securities, Ukrainian Stock Market
Weekly Review. http://www.brama.com/
8. Ukrainian financial server, news and publications about
Ukrainian financial market http://www.ufs.kiev.ua
9. USAID, current activities and analysis of situation in
Ukraine http://www.usaid.gov/country/ee/ua/
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