A simple, step-by-step induction course in capital statements
By Christos P Panayiotides
Given the declared intention of our lawmakers to patch up the legislation governing the compilation and publication of capital statements of politically exposed persons, and in view of the unbelievable cock-up of their previous attempt to come up with a meaningful piece of legislation that would serve its intended purpose, here is a simple, step-by-step induction course on capital statements to ensure that they understand what the process entails and will avoid their previous mistakes. Hopefully, this course will also prove helpful to the intended users of the information, by enabling them to evaluate it correctly.
What is the intended purpose of capital statements?
The idea is that capital or wealth statements are compiled on two different dates. Then, the two capital statements are “bridged”, by identifying and quantifying the sources of income/receipts that have resulted in the increase of the net wealth in the intervening period and the uses of wealth (expenses and outflows) that have resulted in the decrease of the net wealth in the same period. Any unbridgeable gaps would signify the need to launch an investigation.
What is net wealth?
Net wealth or net assets is the aggregate value of all the assets owned, less the aggregate value of all the liabilities (obligations) owed to third parties on the same date.
On what basis should the assets and the liabilities be measured?
The principal purpose of capital statements is not to determine how rich or how poor the person compiling the statements is. The intended purpose is to explain or justify the increase or decrease of the net assets, in the intervening period between two consecutive capital statements. For this reason, all the assets reported should be quantified at the cost of their acquisition (as opposed to their current market value). Measuring assets at their current market value would inevitably bring into the equation the increases/decreases in net assets resulting from the fluctuations in market values (capital gains or losses). Bringing into the bridging process unrealised gains or losses would serve no purpose other than to complicate matters.
Of course, what is totally unacceptable is what we have seen happening in practice, namely the reporting of some assets at their historic cost and other assets at their market value. This is the equivalent of adding together apples with potatoes. It follows that specific inherited assets (such as immovable property) should be reported at a nominal value of, say, €1, thus avoiding the need to commission a valuation of such assets every time a capital statement is compiled. Accounting for such unrealised capital gains or losses would not only be difficult but it would also be meaningless. Ideally, the individually reported monetary amounts (in euros) should be rounded up or down to the nearest thousand, thus avoiding the blurring of the picture with insignificant digits.
What should the standard reportable asset categories be?
The reportable assets are usually distinguished under the following categories:
- Bank deposits, including cash
- Investments in negotiable instruments (such as shares, bonds etc.)
- Investments in related entities
- Current accounts maintained with related parties
- Receivables from loans advanced to third parties
- Payables to loans obtained from third parties (“negative assets”)
- Immovable property at acquisition cost
- Vehicles, boats, aircraft etc, at acquisition cost
- Works of art and jewellery, at acquisition cost
- Furniture, fittings and miscellaneous other assets, at acquisition cost
What should the reportable level of detail be?
This is a matter that needs to be clarified in the legislation. The detailed information that is (or should be) of no interest to the public could be disclosed in supporting schedules that will have to be filed (for verification purposes) but would not be disclosed to the public. Such an approach would overcome the problem of publicly disclosing bank account numbers, home addresses, vehicle registration numbers and the like. Undoubtedly, those media, which intend to utilise such details as a basis for gossip, will be disappointed by such a provision.
Whose assets should be included?
Including the assets and the liabilities of spouses and under-age children in the capital statements is an absolute must. Excluding spouses and children renders the process a totally meaningless and wasteful exercise. This is clearly demonstrated by the following example: X receives a bribe of €1 million, which is deposited into his bank account. A day before the date at which his capital statement is compiled, he transfers the €1 million into another bank account opened in the name of his 14-year-old daughter. The transaction would not be reflected in the capital statement of the politically exposed person. You may as well scrap the system altogether, if you do not want to include the spouses and under-age kids.
What is an appropriate time interval between two capital statements?
Clearly, detecting the existence of a problem (e.g. the collection of a bribe) at an early stage is highly desirable. The compilation and publication of capital statements on an annual basis would facilitate the early detection of malpractices but it would also impose the discipline required for responding to this obligation efficiently, thus rendering the task easier to tackle. There is no doubt that it is much easier to collect the necessary information at the end of each calendar year. In the case of persons who become obliged to compile a capital statement in the middle of a calendar year, the capital statement should be compiled as at the beginning of that year while in the case of those who cease to have such an obligation in the course of a given calendar year, the last capital statement should be compiled as at the end of that calendar year.
How are two capital statements bridged?
The inflows of funds, which result in an increase of the previously reported net assets, and the outflows, which result in a decrease of the previously reported net assets, must be distinguished under the following categories:
- Income from trade, a profession or a vocation
- Salaried income
- Pension income
- Property-related income (rent, royalties, patents etc.)
- Interest income
- Dividend income
- Other income
- Redemption of life assurance policies
- Capital gains realised in the period
- Donations and gifts received
- Income and similar taxes levied
- Other taxes levied (such as property taxes etc.)
- Obligatory contributions (such as social insurance contributions etc.)
- Optional contributions (such as insurance premiums etc.)
- Interest expenses and related costs (on loans owed etc.)
- Capital losses realised in the period
- Donations and gifts given
- Living expenses (including rent expenses, school fees, travel costs, entertainment expenses, clothing costs, recreation expenses, house and vehicle maintenance costs etc.)
Exceptionally, unrealised exchange gains and losses on bank deposits and near cash equivalents denominated in foreign currencies must be recognised, given that it is totally impracticable and meaningless to measure these assets (in the reporting currency) at their historic cost.
What about beneficial interests in trusts?
In simple terms, a “trust” is an arrangement under which the legal owner of an asset (the “trustee”) is a different person to the “beneficial owner” of the asset. I am of the opinion that, if our lawmakers mean business, they must make the disclosure of such trust arrangements and the inclusion of the underlying assets held by trusts in the capital statements compiled by politically exposed persons, their spouses and underage children compulsory.
Who should accept sign for the capital statements?
The person compiling the capital statements and his/her spouse.
Who should certify the capital statements?
A certified public accountant, appointed by the person obliged to compile the capital statements, should certify the statements for reasonableness and completeness and for being in harmony with other related records (such as accounting records kept, tax returns filed, bank statements etc.). The involvement of a professional accountant in the process will – as a minimum – eliminate the blatant mistakes committed by the ignorance and technical deficiency of those having the obligation to compile and file these statements. It is fair that a standardised state allowance should be given to cover this cost.
What should the consequences of intentionally filing a false capital statement be?
Filing such a statement should be a criminal offence. Apart from imprisonment and the imposition of fines, any person found guilty of such an offence by a court of law should be disqualified from holding a public office.
The failure to correct the serious problems and deficiencies identified in the legislation previously enacted would be a strong indication that the requirements introduced were merely intended to give the impression that the public interest was being protected but, in reality, it was left as exposed as it could possibly be.
Christos Panayiotides is a certified public accountant and a regular columnist writing in the Cyprus Mail and in Alithia