APRIL 2017 – ‘ACCOUNTANCY’ MAGAZINE
The impediment of accounting clutter
Management accounts have never been subjected to the rigorous straightjacket of regulatory standards because people running businesses base their internal accounting systems on utility, or relevance to their needs.
In an ideal world, users of published financial statements would be consulted on utility before involving the esoteric speculations of standard-setting technicians. But the expanding panoply of national and international accounting standards appears to have little regard to the needs of users, who are increasingly obliged to ignore, or “add back”, stuff that should never have been there in the first place.
reams of disclosure that add no value whatsoever
Under our regulatory feeding frenzy new accounting rules spawn a host of “clarifying” interpretations – an unstoppable process, generating reams of disclosure that add no value whatsoever. It also breeds a host of specialist consultancies in professional auditing firms and technical departments in every large company’s finance division.
The Keynesian prescription for reviving a stalling economy – paying workers for digging holes, and then filling them up again – could now be replaced by paying accounting technicians to dream up new requirements, prescribe volumes of interpretations, and then restore reality by adding back the resulting tripe!
Leases, for example
There are two distinct types of lease, operational and finance, both of which concern assets that the user does not own. When an operational lease expires, the lessee simply returns the asset to the lessor. The economic reality is that there is no transfer of ownership, and so the asset will not appear on the lessee’s balance sheet.
Finance leases are different. The lessee in effect borrows money to acquire the asset over a defined period. Lease payments therefore include both finance charges and acquisition costs. Risks and rewards of ownership having been transferred, both the asset and the liability for future lease payments must appear on the lessee’s balance sheet. The “true and fair” presentation of such basic principles has historically been unproblematic.
a web of highly inventive artificiality
Not now. In a web of highly inventive artificiality, a coming international standard, IFRS 16, will fudge reality by treating operating leases in the same way as finance leases – despite the fact that no transfer of ownership is involved. Assets hired, but not owned, under operating leases will nevertheless be brought onto the lessee’s balance sheet as “right of use” assets, and balanced by an equally contrived “obligation” to make future lease payments. Rental payments will disappear from operating expenses (to be lost in amortisation charges), and EBITDA ratios will magically be improved at a stroke.
The distortion facility is virtually limitless. This nonsense will fundamentally alter key valuation measures and leverage ratios used by banks, financiers and valuers involved in M & A work. In practice the distorting figures will simply be added back by analysts who will then substitute realistic figures. Accounting wizards never consider the collateral damage wrought by their musings: aggravation and cost!
Other standards too
The purpose of IFRS 7 is to oblige entities “to evaluate the significance of financial instruments, the nature and extent of risks arising from them and how entities manage those risks.” Result? The “guide” alone runs to over 60 pages. The detailed disclosures finish up as a morass of verbiage that scarcely anyone will bother to read, still less understand. The same applies to such recondite topics as share-based payments; employee benefits; fair values of non-listed instruments; and deferred tax calculations. In all cases preparers have to use unverifiable assumptions to produce pages of meaningless disclosure that add no value – other than keeping armies of technocrats off the streets!
Stock exchange pleadings
Stock exchanges everywhere complain that excessive, confusing and immaterial disclosures render financial statements unfit for purpose. Their plea is to “declutter” the accounts.
Their plea is to “declutter” the accounts.
To quote from the latest report of one international stock exchange: “There is now a serious risk that unnecessarily long and protracted statements may fail in their stated objective of providing information that is useful to existing and potential investors, lenders and other creditors.”
And where will it all lead? The madness must end at some point and the emperor’s true nakedness revealed. He will, at last, be given a suit of clothing that actually fits. As with management accounts, the concept of “usefulness” will re-emerge.