There's been some press attention to a speech that Andy Haldane, a Bank of England director, gave at the ICAEW's Information for Better Markets conference in December.

Of most interest to the media was the suggestion that banks ought to be able to follow a different set of standards to other businesses because, basically, banks are different. I'm afraid I don't agree.

Having discussed this a bit on Twitter, I do share Frances Coppola's concern over banks following the fair value model in a rising market, then seeking to abandon it when the market falls. But the accounting rules were very clear about what should be done. It was unacceptable political interference in those standards that led to the rules being relaxed. It's not clear to me how aligning bank accounting standards with prudential regulation will reduce political meddling. If anything, wouldn't it be likely to make it easier?

Secondly, we just don't need to change accounting standards to make prudential regulation more effective. The regulator already has a lot of power at its disposal to demand information. So why not use those powers instead of reducing the usefulness of information available for shareholders? The precedent is there in corporate tax: the tax authorities request what they need, and amend information in the financial statements if necessary. No serious commentator has suggested aligning tax and financial reporting to reduce tax avoidance. And Haldane's suggestion fails for the same reason.

Filed under: Accounting, Regulation with tags andy haldane, bank of england, banks, frances coppola, fsa, ifrs, prudential regulation
59421 Comment »http%3A%2F%2Fwww.fcablog.org.uk%2F2012%2F01%2Fbanks-should-retain-the-same-accounting-standards-as-other-businesses%2FBanks+should+retain+the+same+accounting+standards+as+other+businesses2012-01-23+12%3A55%3A00Christie+Malryhttp%3A%2F%2Fwww.fcablog.org.uk%2F%3Fp%3D5942

The FRC has issued some more guidance for directors. It arrives just before the reporting season starts, so I suppose there's still time for directors to take this advice on board.

It recommends that directors should consider, where relevant:

• The company’s exposure to country risk, direct or to the extent practical indirect through financial instruments but also in terms of exposure to trading counterparties (customers and suppliers);
• The impact of austerity measures being adopted in a number of countries on the company’s forecasts, impairment testing, going concern considerations, etc.;
• Possible consequences of currency events that are not factored into forecasts but may impact reported exposures and sensitivity testing of impairment or going concern considerations; and
• A post balance sheet date event requiring enhanced disclosures to avoid misleading investors.

As tends to be the case with these publications, the FRC has found the right sort of balance between providing helpful stuff that directors will be able to pick up and use and teaching gramma to suck eggs.

Download your own copy here.

Filed under: Accounting with tags austerity, currency, directors, financial reporting council, going concern, post balance sheet events
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I got a bit bored sitting at home over Christmas, so I decided to respond to EFRAG's discussion paper Improving the Financial Reporting of Income Tax, which deals with how companies should report information on their corporation tax liabilities:

Here's what I wrote:

Thank you for the opportunity to comment on your discussion paper "Improving the Financial Reporting of Income Tax".

While some of the proposals in the paper will provide a slight incremental benefit in the quality of reporting, I'm afraid the discussion paper rather misses the point. In paragraph 2.22, you observe correctly that "consolidation rules differ for book and tax purposes" and that this "causes a problem when financial statement[s] are compared to the tax return". This is the root of the difficulty in understanding a global company's tax position from its financial statements. While a company such as, say, Barclays pays tax on the taxable profits earned by its subsidiaries but reports in its accounts the consolidated group profit in accordance with IFRS, there will always be differences. Deferred tax only serves to confuse the position further, because so few users of accounts actually understand it.

I doubt that this problem can be solved by mandating additional disclosures. Instead, I believe that accounts regulators should encourage companies to ensure that they produce tax disclosures that are qualitatively meaningful, and to take action against those whose aren't. I think mandated country-by-country reporting would be a big mistake as it would be too granular and expensive, but companies should be given the freedom to innovate to find new, sensible ways of producing transparent information on their tax positions that inform users. The IASB shouldn't presume that it alone can be the source of these new forms of disclosure.

Filed under: Accounting with tags consolidation, corporation tax, country by country reporting, efrag, iasb, ifrs, innovation
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His new programme, The Written World, tells the international story of writing and its effect on human development. "Writing started in about 3500BC," said Bragg. "And what I find amusing is that it was probably started by a clerk who was tabulating goods going in and out of a market. In other words, we owe all literature to an accountant."

Not a lot of people know that.

Filed under: Accounting, Other blogs with tags guardian, history, melvyn bragg, quote of the day, writing
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The consistently good Adam Smith Institute has published a report that points the finger at IFRS for making the financial crisis worse. It says that IFRS allowed banks to overstate their profits and draw big bonuses based on these illusory gains.

I'm by no means a banking expert, but I am deeply suspicious of the notion that accounting standards caused the crisis. It sounds to me like a thesis designed solely to let regulators, governments and investors off the hook for their own bad choices while unfairly overemphasising the role of financial reporting in the crisis.

The report identifies six main areas that it blames for allowing bankers to overstate their profits. The six areas, together with some initial reflections on them, are as follows:

• Uncertain future cashflows can be recognised as certain by purchasing a credit default swap (CDS) or similar “protection”, even though the supplier of the protection is likely to default if the insured event occurs;

I'm fairly sure that counterparty risk has always been a consideration of any sort of hedging or netting accounting treatment. Certainly if the supplier of the protection is "likely" to default, the hedging treatment would not be permitted. So, the big question must be "likely" in whose opinion? 

• Profits can be recognised from the increased value of assets, or decreased value of liabilities, on the basis of a market price, even though the totality of revalued assets or liabilities could not be sold at that price;

This sounds damning. But I think it's merely observing that if the entire stock of financial assets were sold all at the same time then there would be financial meltdown. Of course. For every seller there has to be a buyer. But there simply aren't enough buyers to pick up all the financial assets if they were to be sold at once.

But I think it's unrealistic to expect preparers to undertake the sophisticated calculus required to determine what would be the market price if they did try to sell all at the same time. Because they're not actually trying to do this, it's a slightly arbitrary exercise. Accounting aims to represent the world as best it can, but it's not trying to produce a perfect economic representation of the company at a point in time. Its preferred approach in this area is to pretend that you could make a marginal sale of these assets at their market price. That's all.

• Profits can be recognised from the increased value of assets, or decreased value of liabilities, even when the revaluation of assets is estimated, not by market prices, but by a model built by bank employees. This is the so-called mark-to-model approach to valuation;

This has long been a problem. Banks create bespoke products for which there really is no market. So, while the accounting treatment for most financial products requires that you look to the market price, in respect of non-market products you must look to the internal model instead. It's less than ideal, but what would you actually do instead?

• The net present value of uncertain future cashflows can be recognised as profits even when they are estimated using implausibly optimistic forecasts. (This is a variation of the mark-to-model problem listed above);

Again with the pejorative language. In whose opinion are they "implausibly optimistic"? Certainly, if the bank's auditors thought they were implausibly optimistic, they would have qualified the accounts. Is this the voice of reason talking or is it the report's author making substantial use of hindsight?

• The EU’s IFRS accounting system, voluntarily adopted by UK and Irish banks at the banking company level, is inconsistent with UK law

Ah yes, I've seen this argument before. And, indeedy, Tim Bush is one of the report's references. I don't really know enough about the law behind it to be able to respond to Bush's argument. But I know it's not universally held by all experts, including those at BIS and the FRC.

• Banks need not make provision for expected losses when calculating their profit.

Well, no. IFRS doesn't let them. But a project to implement some sort of expected loss provisioning is underway at the IASB. The main reason for forbidding expected loss provisioning was that, in the bad old days, banks were using it to smooth income by establishing large general provisions. So the accounting standard setters prohibited any form of forward provisioning. Now that general provisions are felt to be useful, they're being reintroduced. But they were absent by design, not by accident.

I'm left distinctly underwhelmed by the ASI report. It doesn't really reveal anything new. Indeed, all six points would have been known by analysts pre-crash and should have been known by regulators too (if they weren't then the FSA really does need to do some serious soul-searching). While the report does refer to a set of normative proposals to fix the identified problems, it's not clear that they really would work in the way intended. Financial instrument accounting is complex, so a set of solutions that might have helped somewhat in respect of a past crisis may prove insufficient in the face of an unspecified future crisis. 

Filed under: Accounting, Regulation with tags adam smith institute, credit default swaps, financial instruments, fsa, mark to market, tim bush
57311 Comment »http%3A%2F%2Fwww.fcablog.org.uk%2F2011%2F12%2Fthat-asi-report-on-ifrs-exacerbating-the-banking-crisis%2FThat+ASI+report+on+IFRS+exacerbating+the+banking+crisis2011-12-15+21%3A54%3A28Christie+Malryhttp%3A%2F%2Fwww.fcablog.org.uk%2F%3Fp%3D5731

Some bad news for final salary pension schemes in the private sector:

Falling stock markets and corporate bond yields saw deficits - the shortfall between a scheme's assets and liabilities - hit £80billion on 30 November, having stood at £60billion at the end of October, according to consultancy firm Mercer.

This is the perfect storm for pension plans. Soggy stockmarket prices mean that the value of plan assets are low. And low corporate bond yields mean that you discount future liabilities by less, resulting in a higher liability. So the net liability (plan assets less plan liabilities) just gets bigger and bigger.

Ultimately, scheme sponsors may conclude that this problem may never reverse and that they should simply cut their losses and stop all future accruals. Unless, of course, the scheme sponsor is the taxpayer.

Filed under: Accounting, Economics with tags defined benefit, liabilities, mercer, pensions
5687No Comments »http%3A%2F%2Fwww.fcablog.org.uk%2F2011%2F12%2Fits-looking-really-bad-for-private-sector-final-salary-pension-schemes%2FIt%27s+looking+really+bad+for+private+sector+final+salary+pension+schemes2011-12-05+21%3A43%3A23Christie+Malryhttp%3A%2F%2Fwww.fcablog.org.uk%2F%3Fp%3D5687

As a chartered accountant, I get a certain excitement that lesser mortals cannot fathom when opening a set of accounts. Accounts are intriguing; they tell a story and sometimes contain secrets if you're smart enough to unravel them.

So, a day after flipping through the audited Whole of Government Accounts, I'm scratching my head trying to work out just what these accounts are for.

There are two main schools of thought when it comes to accounts. The dominant theory, currently preferred by the main standard setters, including IASB and FASB, is that accounts should contain information useful to enable ordinary people to decide whether to buy or sell shares in the reporting entity. The other theory, which has fallen out of favour but still has some high profile advocates, is that accounts should supply information to owners sufficient to allow them to exercise stewardship over their company.
Neither of these really fits WGA. You can't sell your 'shares' in the UK; even selling the closest thing you've got to a share - your vote - is illegal. So the notion of WGA in informing a buy/sell decision is ludicrous. And the accounts are so long and complex that they're very unlikely to factor significantly in individuals' voting decisions in 2015.

There's a further, and worse, problem. These accounts relate to the year to March 2010. That's nearly two years ago, and relates to the previous, Labour government. The qualifications in the auditor's opinion, referred to in yesterday's blog post, cover decisions going back into the previous decade. So how meaningfully are these going to make government more accountable?

It's good that government has made the effort, and that it has tried to follow a stern set of accounting standards. But these accounts do leave one wondering: just what is the point?

Filed under: Accounting, Politics with tags fasb, government, iasb, stewardship, whole of government accounts
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So, HM Treasury finally published the audited version of its 2010 Whole of Government Accounts, with only a month to spare before the clock ran out. And, as expected, they were qualified. Now, this was the easiest bet in the world - they were always going to be qualified, given their size and complexity. Yet, even so, it's intriguing to see just what they got qualified for. And here's the answer:

Qualification arising from disagreements on the definition and application of the Account boundary

The Government Resources and Accounts Act 2000 (the Act) requires HM Treasury to produce a set of accounts for a group of bodies which appears to HM Treasury to exercise functions of a public nature, or to be entirely or substantially funded from public money. The Act also states that the Accounts should present a true and fair view and conform to generally accepted accounting practice subject to such adaptations as are necessary in the context. HM Treasury has adopted a framework for these Accounts which is based on International Financial Reporting Standards adapted for the public sector context.

However, in Note 1.21.1 to these Accounts, HM Treasury defines the accounting boundary for the Account by reference to those bodies classified as being in the public sector by the Office for National Statistics. I consider that it would be more appropriate to assess the accounting boundary with reference to the accounting standards. By applying such accounting standards, I consider that the Account should include Network Rail.

I also consider that HM Treasury’s accounting policy has not been applied consistently in 2009-10 as a number of significant bodies have not been included in the Accounts, even though they are classified by Office for National Statistics as being in the public sector and which I also consider should be included in the Accounts in line with applicable accounting standards.

Although I cannot quantify the effect of these omissions on the Accounts with certainty as I do not have information needed to identify the transactions that would have to be eliminated to provide a consolidated view, the most significant impact could be on the Account’s Statement of Financial Position.  The exclusion of the following categories of bodies could affect this Statement. To illustrate the potential impact:

• Network Rail which has gross assets of £41.7 billion and gross liabilities of £35.7 billion;

• Publicly-owned banks which have gross assets of £2,862.1 billion and gross liabilities of £2,720.9 billion; and

• Other bodies, such as the Bank of England, which have estimated gross assets of £263.3 billion and gross liabilities of £250.1 billion.

Basically speaking, government screwed up by failing to consolidated a bunch of entities which the auditor thought ought to have been consolidated.  These include Network Rail, the publicly owned banks and the Bank of England. Now, Network Rail is simply wrong on policy grounds. Government doesn't want to consolidate it, but there's no good reason not to. This has been raised by several critics before, including - interestingly - the ICAEW. The argument could possibly be made that the publicly owned banks are being held for resale. But they're included in the public accounts as being in the public sector, so the auditor thinks they should be consolidated in WGA.

Qualification arising from disagreement relating to inconsistent application of accounting policies

HM Treasury’s accounting policies state that the Accounts are prepared on an International Financial Reporting Standards (IFRS) basis, as adapted or interpreted for the public sector context. A number of bodies consolidated in these Accounts do not adopt the same framework under which these Accounts are prepared.  These bodies fall under the following categories:

• Bodies in the local government sector follow the Local Government Statement of Recommended Practice (SORP) for 2009-10, which is based on UK Generally Accepted Accounting Practice (UK GAAP); and

• Bodies that do not apply the Government Financial Reporting Manual but do apply IFRS, UK GAAP, the Charities SORP or NHS Manuals, where appropriate.

Accounting standards require that, where the effect of such inconsistent accounting policies are material, adjustments should be made on consolidation.  HM Treasury has not been able to fully quantify the impact of the different accounting frameworks or accounting policies on the Accounts but it is material in some areas.  An example of the use of different accounting policies is where infrastructure assets included in the Accounts are not valued on a consistent basis. Assets held by local government bodies are valued at historic cost, whereas those held by central government bodies are valued at depreciated replacement cost.  HM Treasury’s estimate of the understatement of assets due to the differences in valuation between historic cost and depreciated replacement cost for local government assets could be at least £200 billion (Note 14.1 to the Accounts). 

This is also a bad qualification. Basically government hasn't been able to get its own entities to apply its accounting standards. And the situation is so bad that the auditor can't really unpick the impact, so he's had to qualify the accounts.

Qualification arising from limitation in audit scope due to lack of evidence supporting the completeness of the elimination of intra-government transactions and balances

Accounting standards require that balances and transactions held and made between bodies consolidated into these Accounts shall be eliminated in full. HM Treasury has a process in place to identify intra-government balances and transactions between bodies consolidated into the Accounts, and most balances and transactions have been eliminated.

However, there remains material values of intra-government transactions and balances which have not been eliminated and the effect of not adjusting for these could lead to a potential overstatement of up to £17.0 billion in gross income and expenditure and up to £6.8 billion in gross assets and liabilities.

I have reviewed the impact of this uncertainty and have assessed that the maximum uncertainty resides within the gross figures in the individual primary statements rather than on the net deficit or net liabilities. The totals reported for the net deficit and the net liabilities are subject to a maximum uncertainty of some £3.2 billion. There is also uncertainty about whether there are amounts which both bodies involved in a relationship have not declared, leading to further overstatement.

This is truly appalling. Basically the government's intercompany balances - the amounts that government departments owe to each other - don't balance. The imbalance is £17bn on the income/expenditure side and £7bn on the assets/liability side. This really is noddy accounting: complex private sector organisations manage it. So why can't government (other than because it's never had to have the discipline in the past)?

Qualification arising from disagreement in the accounting for 3G licences

In April 2000, the government issued licences to access the 3G telecommunications spectrum. Each licence was awarded for 20 years and the total raised was £22.5 billion. This was recognised as £22.5 billion income in 2000-01. I consider that it would be more appropriate to recognise this income in the Accounts over the life of the licences as the licence holders have the right to access the spectrum for 20 years and the government has an ongoing obligation to ensure that the spectrum remains available to licence holders. The impact of this difference is that income would be £1.1 billion greater; liabilities would be £11.4 billion greater; and the value of the general fund would be £11.4 billion less. 

When Tony and Gordon flogged a big section of the airwaves to mobile phone companies, they pocketed the income there and then. The auditor sensibly suggests that a more proper accounting treatment would have been to spread this income over the lifetime of the lease.

Qualification arising from disagreement and limitation in audit scope from underlying statutory audits of
bodies falling within the Accounts

The external auditors of the financial statements of a number of bodies that are consolidated into these Accounts qualified their audit opinion. Of material significance to these Accounts, I qualified the Ministry of Defence’s Resource Accounts on two grounds. Firstly, the Ministry has not complied with the Financial Reporting Framework as it has not accounted for the expenditure, assets and liabilities arising from certain contracts in accordance with International Accounting Standard 17 Leases as interpreted by International Financial Reporting Interpretations Committee 4 Determining whether an Arrangement Contains a Lease. Consequently, the Ministry has omitted a material value of assets and liabilities from its Consolidated Statement of Financial Position as at 31 March 2010.  This has also led to a consequential misstatement of the Consolidated Statement of Revenue and Expenditure for 2009-10.  I am unable to quantify the impact on the financial statements because the Ministry has not maintained the records or obtained the information required to comply with the relevant accounting standards in this respect.

Secondly, I was unable to obtain sufficient, appropriate audit evidence to support the existence and valuation of certain Ministry inventory and non-current assets which are recorded in the accounts at £6.3 billion and the accuracy and completeness of the associated transactions in the Consolidated Statement of Revenue and Expenditure because the evidence available to me was limited due to a failure to maintain adequate accounting records and supporting evidence to operate adequate stocktaking and asset  verification procedures.

Yeah, er, basically the MoD keeps shitty records, so the auditor can't verify everything he needs to. This is also A Bad Thing.

So, all in all, these are a pretty troubling set of qualifications. Failing to consolidated properly, unable to eliminate intercompany transactions and failing to keep proper records are a serious set of problems. However, we should give government some credit, for at least attempting to put together such a complex set of financial statements. No other country has managed what the UK has done so far, but we can be sure that more will now try now that the UK has shown the way forward.

Filed under: Accounting, Politics with tags banks, consolidation, ministry of defence, qualified accounts, whole of government accounts
56291 Comment »http%3A%2F%2Fwww.fcablog.org.uk%2F2011%2F11%2Fthe-qualifications-in-whole-of-government-accounts-2010%2FThe+qualifications+in+Whole+of+Government+Accounts+20102011-11-29+23%3A01%3A55Christie+Malryhttp%3A%2F%2Fwww.fcablog.org.uk%2F%3Fp%3D5629

I make no secret of my total disdain for virtually all financial journalists. So many of them write sloppy, badly-researched stories about financial issues that scream to the world their total lack of understanding of accounting.

But this snippet really is the lowest of the low, in an article on HSBC's third quarter results:

The “reported” profit before tax figure, which gives a less accurate sense of how the business is performing was actually up $3.6bn on the equivalent period of 2010, at $7.2bn, including a $4.1 favourable move in the value of the bank’s own debt. This will not be the figure investors will be looking at, however.

While I can see what they're trying to get at, it's extremely irresponsible to talk of a listed company's GAAP results as "less accurate". It's this sort of nonsense that fuels the idea that IFRS is just a game that companies play, with the full complicity of their auditors, to produce financial numbers that have no direct relevance for investors. IFRS are designed for investors, so if they don't like IFRS numbers, they need to get on the IASB's case to get them changed. But journalists must also do their part to support trust and confidence in reported information. 

Filed under: Accounting with tags banks, hsbc, iasb, idiots, ifrs, sharecast
55751 Comment »http%3A%2F%2Fwww.fcablog.org.uk%2F2011%2F11%2Ffinancial-journalists-are-idiots%2FFinancial+journalists+are+idiots2011-11-10+23%3A06%3A23Christie+Malryhttp%3A%2F%2Fwww.fcablog.org.uk%2F%3Fp%3D5575

The Telegraph has a strange headline for its story today on UBS's latest results:

UBS profits beat forecasts despite rogue trading scandal

UBS has reported a pre-tax profit of close to Sfr1bn (£709m) for the third quarter despite being hit by a Sfr1.8bn loss from an alleged rogue trading incident.

I don't think this is what they mean. Presumably when they broke it to the markets that they'd had a serious fraud, the forecast was restated to take account of it.

So it might certainly be the case that the bank did better than analysts expected. But it's wrong that the scandal had no impact whatsoever on the bank's ability to meet its original forecasts.

Filed under: Accounting, Other blogs with tags banks, fraud, telegraph, ubs
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