Posted by Christie Malry on April 30, 2012 at 9:38 am
KPMG IS THE latest Big Four firm to face criticism from shareholder governance group Pirc, which is calling on shareholders to vote against its re-appointment as auditors of Standard Chartered, Accountancy Age has learned.
The shareholder governance group is urging institutional investors to vote against the bank's annual report; auditors and audit committee chair Rudy Markham because it claims it has failed to to provide a "true and fair view" of its financial position.
In the case of Standard Chartered, Pirc is claiming that the bank's overstated profits include bonuses of $828m that have been deferred but not expensed, and provisions for bad debts that amount to $2.8bn.
Now, I'm no particular friend of the Big 4. But I'm afraid to say that Pirc has got it horribly wrong on both counts.
Bonuses under long term arrangements are recognised over the period over which they vest. Now, a particular concern of politicians and the public has been bankers taking big bonuses today when the bank falls over tomorrow. So pressure has been brought to bear to ensure that bankers must wait several years to collect their bonuses. In order to tie bankers in, the bonuses have "strings" attached, conditions that need to be met in order for the bonus to remain payable. Under IFRS, the bank makes an estimate of the likely level of payment and recognises it over the period of vesting, usually three years. The reason the bank hasn't expensed the profits yet is because they haven't been earned yet. They could still not be paid, should the conditions not be met.
Bad debts in banks are recognised on an "incurred loss" model, ie the bank must have some evidence that a debtor is likely to fail to repay their debts. Now this does understate the level of bad debts because there will be some debts for which there is no evidence today but on which the debtor will default in the future. In the bad old days of 1980s accounting, banks were allowed to provide general provisions for such debts. But the intention wasn't better accounting, it was used to smooth profits out of good periods in order to hide some of the dismal performance in bad periods. This flattered profits during periods of downturn and allowed managers more discretion about meeting targets that might trigger bonuses. Unimpressed, the standard setters removed this subjectivity. The loss provision in the accounts isn't "understated"; it's a deliberate approach that the standard setters are demanding in order to prevent management from cooking the books.
But political pressure being what it is, the standard setters are returning to the "expected loss" model and are very likely to reintroduce it at some point. The idea that it will solve bank reporting at a stroke is, shall we say, unproven.
I find the Pirc campaign pretty frustrating. It's a shame that their knowledge of IFRS is so poor that they can make such fundamental errors. It's also a great pity that their ignorance has gone completely unchallenged by the business editors of the major newspapers. Is there anyone (other than me that is) that is prepared to tell the world they have no clothes?