Accounting's quiet revolution

This year will herald a fight for the heart and soul of financial reporting. Standard setters across the world are planning a move to fair value reporting, which many financial professionals – including many financial directors – view with abhorrence. They see the direction in which accounting and financial reporting is moving as a betrayal of fundamental, long-standing accounting principles in favour of an academic, economics-based view that will lead to accounts being based on incomprehensible financial modelling, so they become volatile, over-complicated – even meaningless.

It’s unlikely that there will be a mass movement of those opposed to fair values storming the gates of the standard setters. Accountants in technical departments at large firms, who are most likely to have the resources and wit to fight, will probably conduct a guerrilla campaign, sniping at particular sections of the proposed rules rather than massing for an all-out attack. They will fight this way because they believe the standard-setting regime is impervious to their concerns and will shout down anyone who opposes them.

The standard setters who are allegedly taking financial reporting away from its roots don’t bother to deny they are on a mission to radically reform it. Their alternative, academic view of accounting is based on the economic theory of income (as stated by 1960s academics Edwards and Bell). Their charge against those who would keep accounts as they are is that only the cash flow gives users of accounts any meaningful information.

The rest – the profit and loss account, the statement of recognised gains and losses, and the balance sheet are a mish-mash of different methods of measurement and valuation – which should be swept away.

Those who wish to introduce fair values ask what exactly the present financial statements actually tell a reader. (The question is rhetorical, for they think the answer is very little.) They say the balance sheet fails to reflect accurately the real assets and liabilities of a wealth generating company in the post-industrial age, and the income statement does not register the real change in status of the entity in the period covered. For them, these modified historical cost accounts wrongly measure the irrelevant and the unimportant, while huge liabilities and assets (notably financial instruments) lurk ready to destroy shareholder value.

Fair value proponents shrug at the charges of meaninglessness, complexity and volatility. As far as they are concerned, fair values tells it as it is. If an aspect of your business – say, for instance, your pension fund – is rapidly decreasing in value, then shareholders should know.

As for the charge of complication, those who argue for fair values say it is the current bastardised system of modified historical cost accounting that causes confusion. They point to Equitable Life as an example. Under fair values the magnitude of the liabilities would have stuck out like an actuary at a rave.

So who is right and who is wrong? Anyone who learnt their accounts in the days of SSAP2 would feel uneasy with the introduction of a standard such as impairment testing. It just doesn’t feel right. The strength of financial reporting and standard setting over the past 40 years is that it has risen from practitioners. But gradually the power of accountants to make up the rules they follow has gone the way of so much self-regulation.

Their reign is being usurped by those who may once have been accountants, but who owe little allegiance to the past.

Over the past few years there has been a sense that the central tenants of accounting and financial reporting statements are increasingly irrelevant and marginal. Yet FDs have not reached any sort of consensus about what income statements and balance sheets should be for. And it may already be too late for them to do so.

The move to fair values will be the biggest shift in accounting and financial reporting since standard setting was set up. We may have moved some way towards fair values, but what is proposed now is a seismic shift. Yet given the convoluted nature of standard setting – with international, European and national regulations backed by primary law – there is not even an arena for open debate on the issues, and this massive change will creep up almost unnoticed. That such a move will be marked by so little debate amongst those with an interest in it is depressing and profoundly disturbing.