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Governance Not Regulation

di - 14 Aprile 2009
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Accountants and Accountancy
Our second example comes from accounting. British (and North American) accounting both derive from the same tradition. The original purpose – and still probably the primary purpose – of company accounts is as follows:
“…in law the object of annual accounts is to assist shareholders in exercising control of the company by enabling them to judge how its affairs have been conducted” (Caparo Industries plc. V Dickman and others: House of Lords, 8th February 1980; Lord Jaunay.)
Such accounting originated from the practice of ‘accounting for ventures’ – for discrete operations, such as a voyage to the Indies – and evolved into accounting for the stewardship of going concerns. In the first, the returns, if any, were divided among the shareholders at the conclusion of the venture. Going concern accounting required regular measurement of profit to determine how much a company could distribute to the ‘shareholders’ without diminishing its capital.
In 1966 there was in the USA a proposal (from the American Accounting Association) to move away from stewardship accounting to accounting for decision making (Myddleton, p36). This was followed up by the US Financial Accounting Standards Board:
“Financial Accounting should provide information that is useful to present and potential investors and creditors and other users in making rational investment, credit and similar decisions.” (p37).
There is thus disagreement about the purpose of accounts, and invariably, as we shall see, disagreement about what kind of regulation of them might be sensible.[2]

For over 50 years British law has required that company accounts provide a ‘true and fair view’ of the state of a company’s affairs and of its profit or loss for the financial year. Thus, so long as the procedure is revealed, different companies can depending on the nature of the business do different things – for writing down old or damaged stock, for allowing for bad debts, for depreciating capital. It is a requirement over outputs rather than over inputs or processes.
Formal accounting standards, restricting the use of judgment, started to be discussed in the UK after the 1967 takeover of Associated Electrical Industries by the General Electric Company. (Before then, there had been “Recommendations on Accounting Principles” – voluntary guidelines on best practice which often described several possible approaches.) After the takeover, AEI’s projected profit of £10mn for the year turned out to be a loss of £4.5 mn. (In fact, two thirds of the turn round was the result of a different judgment about the prospective outcome of long-term contracts.)

But what was laid down was still not a set of standards; rather it was a basic framework from which departures were expected to be disclosed and explained. They were not a code of rigid rules. The over-riding requirement remained to give a ‘true and fair view’.

International accounting standards have emerged in the last 30 years. There are two basic templates: International Financial Reporting Standards (IFRS) and US Generally Accepted Accounting Principles (GAAP).

The differences can be summarised as follows. IFRS is more principle based standards than detailed prescriptions. Under it, ‘true and fair’ is the over-riding rule. Alternative treatments are allowed rather than a single one being prescribed.

US accounting is more authoritarian. This, Myddleton (2004) suggests, is a result of the much greater influence there of government agencies over the subject.
“In the USA ‘presenting fairly’ requires absolute compliance with US GAAP even if it might lead to a misleading view. There is no provision in law or practice for any equivalent of the UK’s ‘true or fair ‘override’.”

What can be said about the positions? What are the arguments for and against imposing a common set of rules?

First the ‘for’. Six arguments for accounting standards are as follows.

They prevent dishonesty by preparers of accounts. Auditors can lack independence. Investors may be damaged without standards. Accounting decisions can be complex. Uniformity in words and layout is helpful. Standards will facilitate cross company comparisons.

Now, how strong are these arguments? All have encountered criticism. It pays insiders to provide information to outsiders. Auditors’ incomes depend in the long run on their honesty. So long as accounts provide a clear account of stewardship they can give no further guidance. Complex tasks can often differ from one another; this can require different solutions. As to uniformity, a sufficient degree tends to evolve. To quote in example a development in a related area, “Prospectuses in the UK (fell) voluntarily into a reasonably uniform format because users liked it that way.” (Myddleton, op. cit. p91)


2.  As an aside, it is worth observing that there appears to be little evidence that company accounts are good at predicting future profits – except of course when they provide evidence of fraudulent or incompetent stewardship. (Benston, 1969)

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