SOVIET ACCOUNTING POSES PROBLEMS

G. Alan Petzet
Senior Staff Writer

Non-Soviet companies negotiating joint enterprises with Soviet entities face radically different situations than they do in other countries with regard to accounting and communications.

Accounting is performed in the Soviet Union for reasons entirely different from those in other countries.

The focus of Soviet accounting is on determining whether individual businesses are meeting state production plans and whether they are appropriating state assets.

The Supreme Soviet and parliament are legislatively considering a number of important changes to accommodate non-Soviet business.

They include allowing nonoperating loss carry forwards, fully accepting accrual accounting, and tax deductibility of bonus payments to employees, said Gerald Rohan of San Francisco, an Ernst & Young executive responsible for coordinating U.S.-Soviet business for the energy industry.

Communications within ministries can be poor and between ministries nearly nonexistent, Rohan said. Legislative changes take time to filter down to officials in the bureaucracy, banks, and other Soviet organizations responsible for implementing them.

Raw materials and components can, with patience, be acquired from within the Soviet Union but not in the same way as in other countries, said Eugene E. Madara, vice-president and chief counsel, engineering and process technology, Combustion Engineering Inc., Stamford, Conn.

Seemingly contradictory information is available from the most reliable sources.

For example, Nicolay Denisenko of the State Foreign Economic Commission of the U.S.S.R. Council of Ministers said joint venturers are granted the right to independently decide questions of employment and discharge, the types and levels of compensation, and bonuses for workers and employees.

However, Charles Hugel, chairman of the National Foreign Trade Council, Washington, D.C., said U.S. companies are restricted in hiring of Soviet staff to using the state service organization and should be permitted to hire from the general population and dismiss unsatisfactory employees.

ACCOUNTING METHODS

There are inconsistencies in virtually every aspect of Soviet and western accounting, said Bruce Edwards, managing partner-developing markets in Europe, Price Waterhouse, New York.

Accounting is used in the West as a way to calculate the profitability or financial health of business concerns and in the Soviet Union as a statistical measure of whether an enterprise is meeting its planned production schedule.

Joint ventures should maintain bookkeeping in accordance with standards set for state owned enterprises because of the strict Soviet regulations imposed on them, Edwards said.

It is a challenge for western accountants to convert financial results of joint enterprises operating in the Soviet Union into results that can be understood by western investors and the U.S. Internal Revenue Service, said Ernst & Young's Rohan. A separate set of books that captures the pertinent information should be kept.

The Ministry of Finance and the state statistics committee have agreed on the forms and specifications of joint venture bookkeeping.

When recording transactions, the joint venture should follow the Ministry of Finance chart of accounts and implementing regulations.

Edwards said U.S. IRS personal income tax form 1040 makes the Soviet forms "look like a piece of cake." Even though Soviet recording requirements can be burdensome, the mechanics are not difficult.

RECOGNIZING SALES

The Soviets generally recognize expenses on an accrual basis as in the West but recognize sales differently, Edwards said.

"In the case of Soviet sales, the West would recognize the sale when the goods or services are delivered, while the Soviets recognize the same sale only when payment for the goods or services is received."

The Soviets recognize a sale on the world market when all settlement documents have gone to the bank for collection.

The timing difference between sale and recognition of revenue creates a gap between recorded profit in Soviet terms and the profit that should have been accounted for in accordance with western accounting conventions, Edwards said.

"Furthermore, this cash basis accounting makes it impossible to reflect business risks in the Soviet books, such as potential losses from outstanding transactions and uncertain liabilities from the sale of production."

INVENTORIES, COSTS

It is not permissible in the Soviet Union to value inventories at anything other than the manufacturing or acquisition costs, Edwards said.

Rent for production facilities, interest on loans, and indirect labor costs, which the West normally would consider part of the cost of goods, cannot be taken into account when calculating manufacturing cost.

Establishment of capital reserve and amortization funds is mandatory, and a number of other funds are optional.

The funds are created from retained earnings because all profits, including dividends to be paid, must be allocated to one fund or another. Money transferred to the funds cannot be used for any other purpose.

There are differences that need to be bridged in accounting for fixed assets. Valuing fixed assets is based on acquisition cost in the Soviet Union and net book value in the West.

Depreciation and acquisition of fixed assets affect the capital account of a Soviet venture but have no accounting effect on paid-in capital in the West.

"These issues impact directly on the profit and loss calculations as we know them because you cannot calculate a meaningful operating profit figure when nearly everything is figured on the basis of the cost of goods sold," Edwards said.

COMMUNICATIONS

The Soviet Union should make a commitment to facilitate telephone, telex and facsimile communication and permit companies to set up satellite dishes and other similar independent capabilities, said the trade council's Hugel.

Internal communication also has shortcomings, said Gerald Knoll, a founder of Dreco Energy Services Ltd., Edmonton.

Dreco in mid-March 1990 shipped the Soviets five well service rigs or component sets consisting of Dreco hoists and masts mounted on modified, heavy Soviet farm tractors.

Dreco was paid a good part of the contract's $2 million up front. The contract calls for full payment 30 days after shipment.

Knoll said Dreco spent large sums completing and verifying documentation and translating final assembly and operating instructions into Russian.

He said poor communications in the Soviet Union impede technological progress.

"I can call Caterpillar, Detroit Diesel, Allison, or Rockwell and find out what components are available," Knoll said. "The Russians can't do that.

"Communication is so bad they don't know what someone else makes in the country.

"Soviet manufacturing plants set up to produce a given item usually make every component for the end product.

"It is a backward production method."

U.S.S.R. SOURCING

Soviet legislation calls for joint enterprises to be supplied outside the official plan.

C-E's Madara said sourcing within the Soviet Union teaches the novice western businessman that the Soviet economy is supply driven rather than demand driven.

"What is available, not what is wanted, determines the outcome of most sourcing transactions," he said.

"When my company was interested in having valve bodies cast in Soviet foundries, we constantly were told by each Soviet facility that, regardless of our metallurgy specifications, what we could have was what the foundry made, not what we ordered. This is a tough lesson to learn."

Consistency of quality of sourced materials varies widely, as does reliability of delivery, often the fault of the Soviet transportation system.

Basic principles of quality control should be written into joint venture foundation documents, said Carol Xueref, International Chamber of Commerce, Paris.

A company considering a joint venture is wise to conduct a market entry study followed by an exhaustive feasibility report, Ernst & Young's Rohan said.

The feasibility report is critical because it challenges all assumptions made in the business plan, such as whether a Soviet partner can supply certain products or has the right to buy them, whether the products can be shipped from partner to partner, whether trucks are available for shipment, and the like.

No detail should be taken for granted, Rohan said.

PRICING, MARKETING

Neither marketing nor pricing has been an operational problem for Combustion Engineering's transactions, Madara said.

"The joint venture is free to market and price as it wishes. We have priced to be competitive, often in hard currency, and have found it to be no different from pricing in the West. "

Madara said Soviet joint venture law limits expatriation of dividends in hard currency to amounts of hard currency generated by the joint venture's operations.

"This means your business plan must contemplate transacting business for hard currency even if you are mainly doing business within the Soviet Union," he said.

"We have found that many Soviet purchasing organizations have hard currency--not necessarily American dollars, but you have to be flexible in your business structuring--or have the ability to borrow the needed hard currency funds...

"Think about taking products in lieu of cash."

Xueref of the international chamber said price establishment formulas should when necessary be anticipated in joint venture foundation documents.

LIQUIDATION, ARBITRATION

C-E's Madara urged joint venturers to discuss liquidation and seek international venue for arbitration before going into business.

Soviet joint venture legislation requires that investors be paid the "residual" value of their capital contributions upon dissolution of the joint venture.

What this means precisely, Madara said, "is one of life's great mysteries and must be clearly stated in the joint venture's documentation.

"My company's experience has been that the Soviets are equally concerned about liquidation dividends, accounting, and so on and are willing to spend a considerable amount of time detailing appraisal procedures, accounting methodology, and payout schedules to mutual satisfaction.

"My advice is to negotiate to a 'fair market value' standard and to restrict payout to either party until both can receive payment. Obviously, your payment should be in hard currency or something else of value to you."

Madara advised against taking disputes before Soviet "arbitral bodies," which are not independent of the state.

Instead, submit them to international arbitration in recognized forums such as the Stockholm Chamber of Commerce, London Court of Arbitration, or International Chamber of Commerce.

"In my experience," Madara said, "the Soviets are willing to accept United Nations Commission on International Trade Law arbitration rules and neutral country law, such as Sweden's, as well."

He urged inclusion in the arbitration clause of a clear trigger compelling the parties to come to the table.

The Soviet party to the agreement may have the defense of "sovereign immunity," which must be waived in the joint venture agreement if the arbitration clause is to be effective.

OUTLOOK

Non-Soviet energy businessmen will find that the attitudes of individual Soviets range from arrogance because the country is the world's largest oil producer to welcome acceptance because of the desperate need for outside assistance, said Rohan of Ernst & Young.

Price Waterhouse's Hammer said, "Investments in the region are not for the fainthearted, large or even small profits will not appear overnight, the lack of convertible currencies throughout the region makes repatriation of any profits problematic, and the absence of wholesale markets in these countries often makes the day to day conduct of a business an exercise in futility.

"Yet for all that, some western investment is being made, and investment will continue as long as the process of reform continues."

C-E's Madara said American businessmen should have no fear of doing business in the Soviet Union.

"My company's experience has been profitable in terms of finance and new friendships and opportunities.

"The essential ground rule, however, is that you do your homework before entering the market and get a clear understanding with your Soviet partner before committing to do anything. After that, it is business like anywhere else in the world."