The scope of the audit report

Posted by Christie Malry on October 26, 2013 at 10:02 pm

Ritchie wants to reduce the quantity of information provided in financial accounts and he has a plan to do that:

I have always argued the data should be and needs to be in readable and downloadable format online and not in printed accounts but covered by the audit report

A link would be enough

The auditor could be protected by them having control of the file once published

And I am arguing for a report per country – not per subsidiary

This is just a terrible idea. Auditors must have a clear scope for what they're going to responsible for. Farming information onto a website doesn't protect them. Firstly, how can the auditor have control over a file that's on somebody else's website? By PGP signing? Secondly, how can the auditors protect themselves from extra information being added to their 'section' of the website?

Alternatively, I suppose, auditors' liability could be capped. But I doubt that's what he's asking for.

Ritchie on limited liability

Posted by Christie Malry on January 11, 2012 at 10:48 pm

On the subject of removing limited liability:

We should be much more straightforward in saying that limited liability is a privilege to be used for the benefit of society, and with care, and that if obligations to society are not respect then it should simply be withdrawn with the shareholders and not society at large then having the duty to remedy the defect. When should that happen? Let me suggest the following occasions for a start:

1) When excess pay is allowed, as noted above.

2) When accounts are not filed on time, for any reason.

3) When corporation tax returns are not filed, for any reason. Of course these are not public documents now: they soon would be if this was the case.

4) Three months after any set of accounts is filed showing the company to be insolvent unless action to remedy the defect has been taken in the meantime.

Now, shareholders are generally considered to be absent owners. They've plonked down their money in a company and then they basically let managers get on with it. The system of corporate governance has evolved in order to ensure that managers don't simply run off with the money or spend it all on booze and fast women. 

The idea of limited liability is to encourage investment. When shareholders aren't worried that they may face future capital calls, they'll be prepared to invest more. 

So the idea that shareholders should lose their limited liability because they wanted to pay a superstar director (or other employee) what they think they're worth is totally ludicrous.

The next three are even more idiotic. Shareholders are, as we said, absent. They've delegated the responsibility of running the company to managers. So why should shareholders be penalised if managers screw up by not filing accounts or tax returns or by trading while insolvent? Ritchie's got this totally wrong. Directors are responsible for ensuring a company isn't trading insolvently, and they suffer if they fail in that responsibility. Not shareholders.

And by 'shareholders' we mean ordinary people like you and me, in our pension funds. It's you and me, Ritchie wants to clobber when directors screw up. Doesn't sound so good now, does it?

Questions from Accountancy Age we can answer

Posted by Christie Malry on October 20, 2011 at 10:18 pm

A mostly good personal think piece in Accountancy Age ends thus:

Lastly has the quiet migration from general partnerships to limited liability partnerships diminished responsibility of the accounting profession in performing audits?

Short answer: No.

Slightly longer answer: Picking on the Big 4 firm I know the best, KPMG, their listed audits are performed through KPMG Audit Plc. This company had, in 2010, current assets of £53 million and net worth of nearly £13 million. I think it's ridiculous to suggest that, because the audit vehicle can now lose only £13 million instead of potentially unlimited sums, individual partners will suddenly act recklessly.

The main reason for partners wanting limited liability is to limit their damages due to other partners' reckless behaviour, not to limit the damages due to their own.

Shaxson's ten reasons for corporation tax, part deux

Posted by Christie Malry on March 15, 2011 at 11:32 pm

OK, back in front of a real computer, so I can spend a bit of time doling out a proper beating to Nick Shaxson's article 10 reasons we should tax corporations.

So, here we go, here's an in-depth analysis of why I think each of his ten points are stupid:

1) Corporate profits depend on tax-financed public goods: healthy and educated workforces; good infrastructure; publicly enforced respect for contracts and property rights, and so on. When corporations avoid or evade tax, legally or illegally, they free ride on the backs of the rest of us. Stop taxing them, and you savagely undermine political community.

Ordinarily when you prepare lists of this sort, you would try to put your strongest point first. So Shaxson has thrown us a curveball by starting with this one. It's designed to tweak the heartstrings of even the most cold hearted of capitalists. But it's nonsense. Corporations can no more "free ride on the backs of the rest of us" than bananas can. Corporations aren't people.

Now, there's a case to be made that we should aim, as far as is humanly possible, to tax every form of economic activity. But that's not what he's said. He thinks people free-riding can 'savagely undermine' community, which is a curiously right-wing notion.

2) Corporation taxes are an essential backstop to personal income tax. Cut them to zero, and wealthy individuals will increasingly reclassify their earnings as corporate income, typically using offshore corporate structures, and escape tax. Gauke's arguments about employees footing the corporate tax bill are irrelevant.

The UK rules on residence and domicile are a bit of a mess. This is partly deliberate, because politicians like to entice rich people to come live here and bring their wealth with them. The price to be paid is an acceptance that they'll maybe pay a lower rate of tax, but because they're richer they'll still end up paying more tax overall.

Hence the rules that someone who is not domiciled in the UK could, until quite recently, pay UK income tax on their UK-sourced income only but pay UK income tax on their other earnings only when remitted to the UK. The government is continuing a plan introduced by Labour to make this remittance route more costly.

Anyone who is resident in the UK and is domiciled in the UK must pay UK tax on their worldwide earnings. If they don't, it's evasion.

So, with that bit of groundwork done, what's Shaxson saying here? He's worried that, without a corporation tax, people will squirrel money away into companies and get that money untaxed. But for UK residents/domiciles this doesn't work. They would still get taxed on the money when they sought to extract it from their company. If they don't declare income they're receiving from overseas sources then that's evasion. The UK government is doing all sorts of deals with other countries to get information about accounts held by UK citizens, in order to ensure that they're being taxed properly.

If they're not UK domiciled then there's possibly more of a problem, but it's a problem that can be solved with enough resolve. A withholding tax on dividends, as would disallowing interest on loans to companies in 'unfriendly' overseas countries.

3) Gauke's claim of a "consensus among economists" that the burden of corporation taxes falls on employees and not on capital owners, is false. The US Congressional Budget Office said last week that it was "unclear" how much of the corporation tax burden fell on employees; earlier, it said that capital bore most or all of the corporate tax burden. The Institute for Taxation and Economic Policy (ITEP) in Washington said this month that the incidence of corporate tax fell mostly on capital owners, not employees. It added that corporate income tax was among the most progressive taxes, because stock ownership was heavily concentrated among the wealthiest taxpayers. This is an especially precious tax.

Gauke's basing his claim on the excellent work of Professor Michael Devereux at the Oxford University Centre for Business Taxation. Instead of reeling off a list of people who don't disagree, it would be better if Shaxson could deal with the flaws in Devereux's method.

4) When Gauke talks about "employees", who does he mean? Goldman Sachs employees earned $430,700 on average last year. To the extent that the burden falls on them, taxing such firms makes the tax system more progressive. It would also cut into excessive bank remuneration, which has been a big factor in the recent financial crisis. Taxing financial corporations also curbs the "too big to fail" problem where large banks can hold governments hostage and shift losses on to taxpayers.

So, having argued in (3) that he doesn't believe Devereux's conclusions, he then decides that he does, but that he likes the symptoms anyway. Arguments (3) and (4) are mutually inconsistent.

Taxing financial institutions quite clearly does not curb the 'too big to fail' problem. Government pockets the juicy tax revenues then blames the banks when they screw up.

5) If corporation taxes didn't fall on the owners of capital, as Gauke claims, then corporations, responding to shareholders' wishes, shouldn't mind being taxed. So why do they spend so much time and money designing tax avoidance strategies?

Because managers, which run companies on behalf of shareholders, do bear some of the burden of taxation because they're employees of those companies. Keep up at the back, Shaxson!

6) Limited liability companies are separate legal persons, greater than the sum of their parts. So they should be taxed separately: this is not "double taxation". Limited liability lets shareholders dump costs on to society when things go wrong. Corporations must pay for this privilege.

This is a distortion of history. Limited liability developed as a way to incentivise entrepreneurs to undertake risky prospective projects. Without entrepreneurs, a great deal of economic output would simply never happen because some of them would be terrified that they might lose their assets, their houses, their livelihoods. Limited liability allows them to partition their business and personal lives. An unfortunate downside is that it can allow directors to ditch a failing company and leave creditors or society in the lurch. That's why we have lots of laws around how directors should behave when their companies might be in trouble.

7) Many corporations earn what economists call rents. These – like oil money that flows effortlessly into Saudi or Kuwaiti coffers – are earnings that arise not from hard work and real innovation but from accidents of nature or good fortune. Adair Turner recently explained how banks in the City of London are particularly adept at earning rents, such as from exploiting insider knowledge and expertise; from natural oligopolies in market-making and other activities; and from "valueless" trading activity. Economists since Adam Smith – including Turner – have advocated taxing rents especially hard.

This point isn't made very convincingly. Sure, rents are bad, m'kay? But enormous amounts of value from oil accrues to, well, Saudi or Kuwaiti sheiks. They're the rent seekers. The oil companies which help them pump the stuff out of the ground in increasingly difficult conditions also make a good return, but they have to do a lot of hard work for it.

8 ) Corporate tax avoidance, despite hiding behind weasel words such as "tax efficiency", is unproductive and inefficient. When corporate managers pursue tax avoidance they take their eye off what they do best – producing better or cheaper goods or services – and focus instead on engineering transfers of wealth from taxpayers to corporations. Clamp down on it, hard, to make markets more efficient.

This point is batty.  Big companies employ a diverse range of professionals. They employ marketing professionals to do marketing, supply chain specialists to manage procurement, manufacturing experts to run their factories and finance experts to prepare their accounts. And they employ tax specialists to ensure that they're not unnecessarily structuring a transaction in a way that leads to a high tax liability when there's an alternative, equivalent transaction that leads to a lower one.

9) It matters where company owners and business activities are. Take a US mining company digging gold in Zambia. If Zambia raises corporation taxes, wealth will flow from wealthy US stockholders to ordinary African taxpayers. The investor will stay, because that's where the gold is – and even if it goes, another will take its place. That basic formula works for profitable opportunities in general. Tax corporations, within reason, and they may bluff and bluster – but they will stay.

But what the local tax authorities are trying to tax is economic activity. They could just as easily tax the wages of local workers. Oh, they do.

If you want to tax flows out of the company, then you can do this (withholding tax, disallowing interest to some countries, etc.) without having to tax it in the hands of the company.

10) The "Laffer argument" that corporation tax cuts pay for themselves has been thoroughly debunked. Even Greg Mankiw, formerly chairman of George W Bush's Council of Economic Advisers, calls Laffer's adherents "charlatans and cranks".

Well the discussion over at CiF makes it clear that this is a gross misquote of what Mankiw said. Of course it is. The Laffer curve is self evidently true - you raise no revenue at 0% and 100% and you raise something in-between. At some point, with higher tax rates, the yield curve must face downwards.

In his haste to find ten reasons to support a corporation tax, Shaxson has overlooked the most obvious and best reason to tax companies - because they're full of money. It's nothing to do with fairness, or Laffer curves, or tax incidence, or non doms. It's just that they make money and governments like to tax where the money is.

Addressing Ritchie's 17 questions on accounting regulation

Posted by Christie Malry on March 16, 2010 at 11:10 pm

Ritchie sets out his seventeen questions that, in his view, need to be answered. So let's answer them.

1. Why we gave up control of accounting disclosure to the accounting profession
2. Why we gave up control of auditing regulation to the auditing profession

There's simply no evidence of this. Yes, the IASB and FASB both contain people who used to be preparers (is this what Ritchie means by the accounting profession? It's not clear) and people who used to be auditors. I think we'd be flabbergasted if this weren't the case. The alternative - regulation being made by people with absolutely no knowledge of the topics they're tasked with regulating - is too awful to contemplate. Only a raving madman would advocate it.

However, there are added controls to ensure that both boards don't get captured by any special interest group, and that they meet their overall strategic objectives. In the case of the IASB, this is the role of the IFRS Foundation (formerly the IASCF), which operates according to a constitution.

At every stage, there are public consultations. Anyone can respond with their points of view. The IASB and FASB are held accountable to the proper operation of their consultative processes.

3. Why we allowed the definition of an audit to be limited to confirmation of compliance with an accounting framework and abandoned the true and fair override

Because we didn't. The UK Financial Reporting Council has obtained Counsel's opinion that has confirmed the centrality of the true and fair requirement to the preparation of financial statements in the UK, whether they are prepared in accordance with international or UK accounting standards.

The European Union endorsement process only permits endorsement of a standard if it "it is not contrary to the 'true and fair principle' set out in Article 16(3) of Council Directive 83/349/EEC and Article 2(3) of Council Directive 78/660/EEC." (source:

US GAAP, as a result of legal cases (e.g. Global Crossing, see Lehmans Examiner Report vol 3, p.965) and Sarbanes-Oxley (s302) requires financial statements to be not misleading. Merely following GAAP is insufficient to fulfil this requirement.

4. Why we allowed the users of financial statements to be considered the providers of capital alone
5. Why we don’t demand financial statements that meet the needs of other major user groups including:
a. Employees
b. Suppliers
c. Customers
d. Regulators
e. Tax authorities
f. Civil society groups
g. People at large

These two questions go together. Frankly, they're idiotic. Companies produce their annual accounts for shareholders. That's what the annual accounts are for. It's right that the regulations over the form and content of accounts should put shareholders first.

Other people find accounts useful, and it's right that they can access material that's filed on the public record. However it's daft to suppose that you could ever have a one-size-fits-all approach to financial reporting.

Employees, especially those involved in financial management or strategy, will always need a different form of reporting. And they have one - in management accounts. Management can determine the form and content of information needed by employees generally. It's a place regulation doesn't need to be.

Suppliers may find the information in company accounts useful. However, accounts take time to prepare, and by the time the supplier is considering extending credit to a company it may be some 18 months after the balance sheet date. So suppliers will always need additional sources of information, such as credit reference agencies, and will want to increase credit limits only gradually until they trust the company enough.

I don't quite know what Richard has in mind when he says customers need information from accounts. It might help customers in situations such as Farepak or Wrapit, subject to the timing issues identified above. But there are other, better sources of information, and other courses of action they can take, such as using a credit card for added consumer protection.

Regulators and tax authorities are in a privileged information. They often choose to use the financial accounts, because they are signed off by directors who can be fined if they get it wrong and, where audited, have added reliability of an audit report. Both regulators and tax authorities can require additional information to be provided. And both can require companies to submit to inspections. They simply don't need added information to be included in the accounts just for them.

Civil society groups and people at large, to the extent that they are different to any of the aforementioned groups, may also get useful information from financial statements. If they wish, they can buy a small number of shares and then seek further information either directly from the company or at its AGM.

6. Why we limited auditor liability so much

Because audit quality is more important. As of today, auditors of US-listed companies don't enjoy limited liability. I'm not aware of any UK-listed company that has negotiated limited liability for its auditors (that's not to say that there are none). And the Big 4 audit firms are legally separate partnerships. We need to respect the legal form when considering legal liability. It would be perverse to set aside legal process when determining what, legally, is owed to a third party.

7. Why we allowed the concept of limited liability to be porous when it comes to failure and yet so restrictive when it comes to sharing information and reward

I guess we're off auditors' liability for now. It's a one-way street by definition. We permit firms to have limited liability because we all benefit from its existence. Many modern inventions simply wouldn't have been invented at all if investors hadn't been able to protect themselves from future liabilities through the use of limited liability companies. We already dealt with sharing information above. And better profits means more tax revenues for the government.

8. Why we allow limited liability within limited liability i.e. subsidiaries have limited liability distinct from parent companies

Because limited liability pertains to a company and companies can own other companies. Isn't Ritchie supposed to know this sort of stuff?

9. Why we consider group accounts the only useful perspective on corporate activity

Because, by and large, shareholders only own shares in the parent company, which commands the assets of the total group through its subsidiaries. Investors might be interested in subdividing the group, which is why they are required to disclose segmental information, but they're more interested in the overall picture of the consolidated group.

10. Why we allow off balance sheet accounting

And, Ritchie, when did you stop beating your wife?

11. Why we still allow auditors to undertake other commercial activities

Who do you think you are to restrict the purchasing decisions of companies?

In many cases, what is disclosed as non-audit fees are actually intrinsically linked to the audit, and would be considered by the man on the Clapham omnibus as audit work. Thanks to the arcane workings of our regulatory systems, they are not (e.g. see Q21 of the Treasury Committee uncorrected evidence from February 2010).

Non-audit services purchased from the audit firm need to be pre-approved by the audit committee (whereas those that are purchased from other firms do not need pre-approval). If management was genuinely trying to cheat shareholders, they would presumably use anyone other than the auditors, in order to avoid this added level of challenge.

12. Why we don’t increase company registration fees to ensure auditors can always be fairly remunerated from a communally managed purse

Because we're not in a communist country. Thank God.

13. Why we allow companies to not file accounts on public record

All UK limited companies must file accounts at Companies House. Some smaller companies can file abbreviated accounts on the public record.

There's a proposal in the EU to allow member states an option to remove 'micro' (i.e. very small) companies from the requirement to follow the accounting directives, which includes the requirement to file on the public record. Even if it goes through, and there's no certainty that it will, it will still need to be taken up by BIS before it would become law here.

14. Why we accept a lack of transparency on group structures

I seem to recall that UK companies are required to have a registered office, at which they must display the company's full name on a sign. Consolidated accounts list the (parent) company's major subsidiaries. If foreign company law is less good than English company law, then perhaps Ritchie should take that up with them.

15. Why we don’t demand full accounts on public record from all entities created under law wherever they are in the world, whether they be companies, partnerships, all variations on these, trusts, charities, foundations and other such entities. Such information to include full information on ownership, entitlement to assets, establishment, constitutions, management and accounts.

See above. English company law does require information to be filed on the public record. This could, of course, change if the EU micro company proposal goes through. Then we can have a debate about the relative benefits and costs of this requirement.

Other countries have already concluded that there's no need to have accounts on the public record. These aren't "secrecy jurisdictions", but actually the majority of countries around the world.

16. Why we allow companies to be struck off public registers without questions being asked and substantial fees being paid in lieu of accounts.

You've lost me. We fine companies if they don't file accounts on time. Eventually we strike them off if they won't comply.

17. Why fit and proper tests aren’t conducted for all persons incorporating and owning companies.

We prefer to ban them once we're proved they're rotten.

Why we tolerate limited liability

Posted by Christie Malry on March 16, 2010 at 9:17 pm

And even more.

Now is the time for the most fundamental review of what the limited liability entity is, why we allow it, what its rights and obligations are and how we regulate it.

Because we decided long ago that the substantial benefits society reaps as a result of encouraging funding providers and entrepreneurs to work together outweigh the costs of limited liability.


Mutualisation - pie in the sky.

Posted by Christie Malry on March 13, 2010 at 2:41 pm

Halifax Building SocietyA Guardian editorial argues in favour of mutualisation in the private sector.

Having more mutuals in the private sector would be a fine thing.

Why? The history of mutual organisations isn't exactly a ringing endorsement of the concept.

It's a fabulous ideal - the idea that we can all get along with each other and share nicely. But people simply don't behave like that. Think of Factory records. Wouldn't it be nice if record labels let their artists keep the rights of the music they produce, instead of the big bad record label hogging the lot? Er, no... it meant their biggest artists could run up huge bills recording albums and then walk off with the resulting album, leaving their debts behind. Factory Records went bust as a consequence.

The very idea of the limited liability company sprang from the need to prevent partnerships being broken up unnecessarily because one partner wanted out. Although it was possible (using contract) to draw up partnership agreements that could prevent one partner blackmailing the others, these couldn't survive the death or insanity of a partner. The limited liability company provided a vehicle that would live beyond its owners.

20 years ago, there were many mutual organisations active in the UK financial services sector. Unfortunately, people collectively voted to demutualise them and pocket the proceeds. Many of the demutualised societies were subsequently taken over, or failed. Conversely, the largest mutual, Nationwide Building Society, survived and is still thriving.

We simply can't be trusted to act in our long-term best interests, instead of taking the short-term advantage. And that's why mutualisation is doomed from the start.

Hooray for limited liability

Posted by Christie Malry on March 13, 2010 at 2:12 pm

Chester City losing againSo, Chester City Football Club, a fine club with a 125 year history, is being wound up after being unable to pay its debts. These included debts of £26,125 owed to HMRC.

Plans are already underway to form a brand new club, spookily also based in Chester, to replace the liquidated club.

People sometimes ask whether it's still ethical to allow companies to fail, leaving creditors out of pocket, only to rise again from the dead to trade once more. Why not seek the views of Chester City's fans? Why should they not be able to set up a brand new club just because they were unfortunate enough to get lumbered with incompetent management who burdened their club with impossible debts?

The point of limited liability

Posted by Christie Malry on March 8, 2010 at 8:36 pm

Richard muses on limited liability.

Now they want the people of Iceland to repay them even though the banks in question had limited liability

Because Landsbanki operated in Iceland and as a branch in the UK, we want the people of Iceland to underwrite all bank accounts on the same basis. The government had proposed to underwrite only domestic accounts while ripping off accounts held by Brits. That's not fair.

In the comments, Demetrius writes:

What is happening is that the taxpayer now seems to have unlimited liability and those who run busted companies no liability at all.

This is typical bone-headed socialist thinking. Someone always has to have unlimited liability. If we want to allow entrepreneurs to enjoy limited liability then we must accept that that will sometimes mean that the parties with whom they contract will lose out. When it's the state, that means that the state must either accept unlimited liability, or that what it wants done won't get done.

Agriculture and IndustrySo why, Richard asks, do we tolerate this?

This is easy. Because the alternatives are far worse. If we forced companies to honour onerous contracts, without being able to partition the risks into individual companies using limited liability, then they would enter into fewer contracts ('good', you might say. But this would mean less profitability, fewer jobs, lower employment...). Alternatively, they would seek to cover the additional risk by increasing prices. If the state did not allow investors to protect their personal assets from their investments, then they simply wouldn't invest. 'Carol Wilcox' might think that to be a good thing, but it would mean jobs never created, a smaller economy and lower growth.

Limited liability is a price worth paying for the huge multiplier effect it has on our economy. Without it, we'd all be much poorer.

The Icelandic no

Posted by Christie Malry on March 7, 2010 at 11:35 am

IcelandPredictably, the Icelandic nation has said 'no' when asked if they wanted to pay a bunch of British and Dutch strangers the full amount of their bank deposits, lost when various Icelandic banks ran into trouble in 2008. The situation is fiendishly complex, with some banks operating as subsidiaries here and some operating as branches of non-UK subsidiaries.

Ordinarily, when a UK saver is at risk of losing money because their bank or building society has run into trouble, they can get some of it back thanks to the Financial Savings Compensation Scheme. However, this doesn't apply to foreign banks operating as branches in the UK. The Icelandic situation exposed a loophole in our banking regulation - Icelandic banks were able to operate here because Iceland is a member of the European Economic Area (not the same as the EU). Roughly speaking, this meant that the FSA presumed that the local regulator, in Landsbanki's case - The Financial Supervisory Authority (FME) - was competent and would provide the minimum standard of consumer protection required by EEA agreements. To the extent that the FSCS provides better protection, the FSCS will top up to its protection only after the EEA protection has been exhausted.

Unfortunately, here it gets messy. Because the UK government wanted to stabilise market confidence, it guaranteed the deposits of all UK savers when the Icelandic banks failed. At the same time, the Icelandic government, which took control of its failing banks, guaranteed local deposits only. The spat between the UK and Iceland is now whether that Iceland, which stepped in to protect its own citizens, should be responsible for compensating UK savers too.

LandsbankiFor the banks which operated as subsidiaries, my view is that company law should be respected. In other words, no matter how unpalatable it might be for UK savers, the Icelandic government should be able to limit its liability solely to the share capital of that subsidiary, subject only to any binding agreements on top (such as the EEA guarantees). Limited liability should be respected, and we should let them walk away.

But where it was a single entity operating in both jurisdictions, I don't think it's acceptable to discriminate in favour of one set of savers over another. Creditors should be ranked, with Icelandic creditors and UK creditors ranking equally. If they want to guarantee Icelandic savers' funds, they should only be able to do that by guaranteeing all savers' funds.

I'm not surprised that the Icelandic people voted 'no' - their banks owed a lot of money and it would have been painful to pay it all back. There will be some serious consequences for their country as a result - starting with being placed somewhere behind Turkey in the queue of people to join the European Union. But at the heart is whether it is ethical to discriminate between savers solely because of their country of origin. In Landsbanki's case, I don't think the Icelandic government should be able to do that. When they took over the bank, they assumed all its assets and liabilities, including some foreign ones, and they now should not be allowed to compensate savers who can vote for them at the expense of those who cannot.