My repeated warnings to auditors that compliance with IFRS does not guarantee accounting truth and fairness appear to have struck a resounding chord in high places: the House of Lords, to be precise, where the Parliamentary Commission on Banking Standards debated the Bill on banking reform, now enacted by Royal Assent.
In Hansard for 23 October 2013 you will find this contribution from Lord Lawson: “The difficulties with IFRS are huge. Noble Lords may have seen the interesting article [in Accountancy] by Emile Woolf – one of the best known chartered accountants – who writes from time to time. I commend the whole article: noble Lords might find it beneficial, although they will be glad to know that I will not read it all out. Woolf writes that:
‘The lapse of accounting and auditing rigour that has allowed IFRS compliance to dissemble truth and fairness has brought shame on our profession and begs the question of exactly what is our purpose’.
That is pretty strong wording, but it is well justified. True and fair have effectively gone and the importance of prudence has given way to box-ticking.”
Lord Lawson went on to recommend that banks should be required to publish a second set of accounts that could actually be relied on to give a true and fair view. That, despite strong supporting arguments, did not make it into the Act.
What is enacted, however, is that both the Financial Conduct Authority and the Prudential Regulation Authority have a duty to hold meetings with the auditors of each bank and deposit-taking institution at least once in every financial period.
The absence of any statutory agenda for such meetings leaves regulators free to quiz the auditors on any contentious issue, including two identified by Lord Lawson in the October debate: the creation of “purely fictitious paper profits” by mark-to-market accounting, and the adequacy of bad-debt provisioning in the loan book.
New audit rules from Strasbourg
Meanwhile the European Parliament persists with its misdirected efforts to enhance auditor independence and competition. The usual suspects, provision of non-audit services and auditor rotation, feature in the impending legislation (due for adoption this month), but it contains so many permissable variations that we shall finish up with a veritable patchwork of independence rules throughout Europe.
It’s not all bad, however: the rules will require companies to disclose the nature and extent of communications between auditors and the audit committee; deficiencies in internal control and accounting systems; and significant difficulties encountered during the audit. Some rules have potential for actually improving audit effectiveness, such as disclosure of which balance sheet categories have been “directly verified” and which merely subjected to systems or compliance testing. They also require a report on the valuation methods applied to items in the accounts.
Swallowing management estimates without question will presumably not count as a “valuation method”, nor as “direct verification”. We know only too well that spinelessly gullible loan-book valuations in US and European audits played a key part in the credit crisis and the wave of bank bailouts that followed.
As with any addiction, whether those hooked are people, institutions or countries, they just go on doing it, with less and less regard for the consequences that inexorably follow. The habit catches on: EU finance ministers have just agreed to place Croatia under “Excessive Deficit Procedure” before agreeing a bailout, requiring its government to present a plan to reduce its public deficit to 3% of GDP by 2016. And Croatia, ranked as one of the most corrupt nations in the EU with 20% unemployment, became a member only last July, after 10 years of close monitoring and meeting all those stringent EU entry criteria!
Can you imagine any EU or IMF official squandering his own money in this way? It’s so easy to put entire nations on the dole, promising that they will not need to pay their own welfare bills, but should just send them to Brussels.
We know that Croatia, like Greece, Ukraine and a dozen other bankrupt states before it, will present its “plan”; will never meet its conditions; and will get its bailout money all the same – in the form of printed-to-purpose ECB fiat bonds, worth less and less every day.