UK accounting standards are celebrating their 40th birthday: Statement of Standard Accounting Practice No.1 on associated companies was issued in 1971. The initiative was given a boost in 1973 following exposure of Robert Maxwell’s deceits at Pergamon Press.
In a hotly contested takeover battle Pergamon’s share price was supported by accounts that included a wildly exaggerated valuation of the company’s stock of scientific back numbers. DTI inspectors concluded that Maxwell was not a person to whom stewardship of a public company should be entrusted.
In 1976 the Accounting Standards Committee was set up to develop a system of definitive standards for financial reporting that would endow accounts with clarity, rigour and consistency, as an antidote to earlier scandals. The perceived problem was that statutory accounting requirements allowed for interpretations susceptible to management bias, and the formulation of accounting policies that presented results more favourable than warranted.
Four decades on, we have national and international regulators, state-run agencies, standard-setters and harmonizers in droves. Result? We are hamstrung by accounting rules that demand more interpretation than ever before, and management can still dissemble results. Sir David Tweedie summed it up perfectly in 2008 when he admitted that the average partner couldn’t do an audit without referring to academic specialists in the technical department. “Well, that’s crazy” he said, “We’ve just got to get accounting back to the profession”.
standard setting has been insidiously appropriated by very clever people
Over the years, standard setting has been insidiously appropriated by very clever people who have no conception of what it’s like for those in the real world, who cannot fathom the meaning or purpose of their inscrutable concoctions – despite the so-called “intellectual purity” with which they are conceived!
The finance director of one PLC included a note on non-compliance rather than being driven insane: “In view of the size of the property portfolio, and the complexity of determining the residual values and anticipated sale dates of these properties, and the fact that any deferred tax liability raised will be offset by deferred tax assets, management believe that an exercise to determine the requisite amounts would require expenditure well in excess of any expected benefit.”
Who can blame him? The “fair value” mania generates a deferred tax “liability” that may never be paid – and it isn’t a liability anyway, under the standard-setter’s own definition. Valuing land and buildings separately, calculating deferred tax on buildings only, splitting it between “recover through use” and “recover through sale”, and then applying different tax rates over different time horizons – to what purpose?
Facilitating the banking crisis
Prudent lending was once practised by bankers who never forgot it wasn’t their money they were lending. The avarice of investment bankers put paid to that principle when IFRS rules imposed risk models requiring only “incurred” losses to impact their balance sheets. “Inherent” losses, that silently ravaged their loan books, stayed off-balance sheet. Mervyn King’s reference to Northern Rock was delectable: “The assets side of its balance sheet suddenly became highly illiquid.” It was always illiquid, but the contrivance of “marking-to-market” concealed that.
You would have expected the earlier Icelandic catastrophe to sound warnings. Its three largest banks were sitting on loan books totalling ten times Iceland’s GDP. All carried clean audit opinions – and then they imploded.
Should we despair over the very notion of effective regulation? As I observed last month, every aberration deployed at Enron continues, freshly disguised, to flourish with the full backing of reporting standards and lawyers in the opinion-shopping bazaar.
Audit is, and always has been, the key. The obscure accounting rule that enabled banks to hide billions of debt at every reporting date did not oblige their auditors to bless an unvarnished accounting travesty. Compliance? Maybe. Truth? Never!
In his masterwork, “The Great Wall Street Scandal”, Raymond Dirks concluded: “When conscience is immobilised, public trust has disappeared. At that point, by default, institutions become omnipotent.”
He wrote that 37 years ago.