“Accountancy” Magazine – October 2016

Standard-setting or obfuscation?

The accounting world has become shrouded in complexity, largely of its own making. Here’s an uncontroversial statement of its original purpose: “To report the results of an entity’s economic transactions in accordance with well-understood and generally accepted accounting principles”.

Here is an equally uncontroversial statement: No enterprise would get off the ground without “capital”, and accounting’s role is to record its alternative forms, such as liquid assets; stocks of finished products; or fixed assets – and whether those running the enterprise prefer to purchase such assets outright or retain flexibility by entering into a lease agreement and paying rent for their use.

Is the commercial world so complicated that accounting for such simple concepts must fall victim to a relentless drive for complexity? No longer an objective portrayer of commercial activity, accounting technology has seized the controls and taken on a life of its own.

‘Simple’ lease accounting

Leasing is a case in point: under a so-called “operating” lease the lessee pays a rent for the asset’s use and nothing appears on its balance sheet. Alternatively, the lessee could enter into a “finance” lease, effectively borrowing money to acquire the asset over a defined period. The payments are no longer rent, but are split between finance charges and acquisition costs, and both asset and liability appear on the lessee’s balance sheet. As long as the risks and rewards of ownership have been transferred, these basic accounting principles apply. Simple enough?

Once accounting’s rule-makers get in on the act, nothing is simple – especially when their convoluted stipulations are enacted “in the interests of simplicity”! For example, the latest creature of the standard-setters’ craft, IFRS 16, will abolish the distinction between finance and operating leases by decreeing that all operating leases will, by January 2019, be accounted for “as if” they are finance leases.

What, you may ask, about the fact that under an operating lease no asset is actually acquired? No problem, say our rule-makers, we’ll invent one for you: just “capitalise” the present value of rental payments not yet due, and call it a “right-of-use” asset. And, because it is always a good idea to balance the books, we’ll convert the obligation to pay rent – in future – into a liability. Hey presto!

Reality takes a back seat

This contrivance flies in the face of both legal and factual reality: the lessee has acquired no more of a liability than he has acquired the chimerical asset it purports to represent. The absurdities do not end there: the standard requires notional interest to be charged annually on a notional liability that is not owed to anyone.

As for enhancing comparability, IFRS 16 will destroy it: if Companies A and B have absolutely identical leases, their respective balance sheets will disclose different amounts for the right-of-use “asset” and “liability”, since their present value calculations will use discount rates that depend on the unique borrowing profiles of A and B respectively. Traditional balance sheet ratios – EPS, solvency, debt-to-equity, tangible net worth, leverage – will just have to be reinvented. As for the wider impact of all this fanciful sorcery, sympathy is most aptly felt for those who have to teach it!

And auditors?

Auditing, more than ever, lacks the credibility of an independent discipline. Auditors are co-members of the very same club that generates the nonsense they are supposed to vet – not only within the same profession, but the same firms – whose members have infiltrated even the ranks of regulators, as highlighted in last month’s column on the BHS saga. When legislature (standard setters) and judiciary (auditors) are no longer distinguishable, independence is impossible.

The standard wording of a “clean audit opinion” includes the auditor’s escape clause: the financial statements give a true and fair view “in accordance with [IFRS]”, which is in effect a qualification. It admits, absurdly, that accounts could be declared “true and fair” when drawn up within a palpably flawed IFRS.

Accounting’s most notable contribution has been to create a fictional superstructure that makes it well nigh impossible for the lay investor to understand a set of accounts.

As auditors are so deeply compromised, who will declare the emperor’s new clothes for what they really are?