Unaccountable accounting began three decades ago. I know, because I was there when it happened. As a member of the UK Auditing Practices Committee (APC), I acted as its observer on the Accounting Standards Committee (ASC). Professional life was simpler then: ASC set the accounting standards, effectively UK GAAP, and APC set the auditing standards.
Untroubled by such fanciful notions as harmonising worldwide accounting and auditing rules, we set standards that were understood by directors and shareholders of UK companies, ensuring that financial statements were properly prepared, consistent and intelligible.
Who can claim, honestly, that corporate reporting as currently practised facilitates more reliable interpretation? Ah yes, I know – it’s all far more complex today. But, as usual, we have cause and effect the wrong way round. The complexity is itself a product of the frenetic outpourings of a self-appointed regulatory industry, relentlessly grinding out stuff so turgid that no one with a proper job has time to read, let alone understand, it.
I witnessed the very moment when accounting sense was transfigured into nonsense: a certain member of the ASC, an accounting professor, stood up during one of our meetings and postulated that the prudent practice of showing all assets at the lower of cost and market value should no longer apply to easily realisable current assets, which must instead be “marked-to-market”. Under this so-called “fair value” model a company’s monetary assets – such as acquired loan-books, short-term receivables, bills of exchange or other easily realisable investment holdings – should be restated at their market value, even if above book value.
I voiced my astonishment. Might not reported revenue include unrealised gains? What if the market was volatile? What of susceptibility to manipulation? And the apparent abandonment of prudence as a cardinal principle? But, as a mere observer, I was unable to derail this US-imported hazard, which eventually crept into UK accounting dogma.
Fair value? More like “fair-weather” value! But the weather turned foul and wrought havoc on institutions everywhere. Compared with the level of attrition in the US, the tally of UK banks bailed out by taxpayers was mild. Outfits such as Northern Rock, Anglo-Irish, RBS, Bradford & Bingley and the rest – had solvent balance sheets, passed by illustrious audit firms as true and fair, but went bust just the same when their marked-to-market liquid assets proved to be lethally illiquid. It seems there were no takers for books of irrecoverable loans – at any price! What happened to that “market”?
Those bailouts: accounting should reflect economic law
Of course, those bank bailouts differ from sovereign bailouts in size only. In principle, all latter-day bailouts are funded by central banks with a licence to debase the currency through counterfeit. Contrary to Keynesian myth, printing money unsupported by past production consumes capital. It destroys purchasing power and cannot stimulate growth. The seed-corn of wealth creation is savings, not spending. But when central banks deliberately suppress the natural demand for loanable funds, there is little incentive to save. That’s economic law.
What have standard-setters learned?
Standard-setters and regulators have learned nothing. Despite being condemned as unfit for purpose by the Parliamentary Commission on Banking Standards, these flawed accounting rules still allow institutions holding palpably irrecoverable mortgage debts to keep them on the balance sheet, via some creative “rescheduling”. The Chairman of IASB, Hans Hoogervorst, appears to oppose prudence because it facilitates “earnings management”. As Stella Fearnley of Bournemouth University recently put it, “What do we pay auditors for?” Good question.
I actually asked a Big-4 auditor, at the peak of the crisis, whether his firm’s procedures included sampling individual mortgages and loans in a “parcel” of instruments purchased by his client – after all, how else would you assess borrowers’ ability to repay, and hence whether a write-down or provision was warranted?
That, I was told, was management’s job. It was not within the audit scope to vet the commercial viability of the client’s business plan. The auditor’s job is to establish that the transaction is correctly recorded and presented in compliance with the standard.
Ah well, Armageddon beckons.