Between a rock and hard place

There is a growing gap between the standard of the financial reporting process as set out in codes and guides, and the day-to-day reality in Britain’s plcs. The inability or unwillingness to reconcile the two is puzzling. The corporate governance failure rate we see among companies is high enough in these relatively benign economic conditions to suggest that failure is not the exclusive preserve of the reckless or the hopeless – so much so that one wonders if the financial reporting standards we attempt to impose on companies are too high, or perhaps we expect too much integrity from the financial reporting process of organisations whose primary purpose is to create shareholder wealth.

It was somewhat surprising when the Mayflower Corporation, Britain’s largest bus maker, announced last month that it had placed most of its operations into administration. The group was actually profitable but was saddled with debts of nearly 10 times profits. The group’s lenders were already showing their impatience, as demonstrated by the announcement just days prior to the step into administration of the departure of three top executives, including the FD, and the appointment of an interim FD and chief restructuring officer.

The last straw for the group’s backers seems to have been the problem with the accounting system. Mayflower announced it had discovered irregularities in its TransBus Division, relating principally “to delays in passing on payments from customers to one of the group’s finance providers”. The company said the adjustments required as a result of the irregularities were likely to increase the group’s previously announced net debt figure by no more than £20m. The adjustments were not expected to hit profits, although investigations by PricewaterhouseCoopers continue.

The tale of yet another accounting crisis at a quoted company appeared at the same time as the wary non-executive director was being targeted with another shed load of advice, this time from the Institute of Chartered Accountants in England and Wales. As part of a series, the ICAEW has prepared advice for audit committees on monitoring the integrity of financial statements. One of the main roles of a company’s audit committee is to monitor the integrity of the financial statements and other formal announcements relating to financial performance. The guidance points out that most of transactions are routine. It is the remaining non-standard transactions that require most attention.

The first issue for directors is knowing what to be worried about. As the guidance says: “The determination as to whether a judgement is significant will vary between companies and there is no single criterion or set of criteria that can be applied universally.”

The problem with the advice from the ICAEW is that it assumes all the accounting systems and the numbers are in place, working and producing meaningful numbers. Judgements can only be made on the information that is made available to the directors. Non-executive directors, in particular, are dependent on the data presented to them. One of the key roles of non-executives must be not only to challenge the executive directors on the decisions they have made, but also on the integrity of the information on which they are basing their decisions. All of the guidance in this area assumes the raw data is OK and that it is up to the board to reach the right decision. But it seems the numbers in the board papers need to be treated with scepticism. It would be interesting to know how many audit committees ask to see the financial controller to check on how confident he or she is that the numbers are right, or talk to the internal and external auditors about compliance work and reconciliations, ensuring they were being performed properly and in a timely fashion.

Non-execs should also check that the numbers they are looking at are not the result of spreadsheet jockeying. The Excel spreadsheet has its place, but not in producing financial statements for quoted companies.

Directors should also check that the numbers they see can actually be traced by the numbers the system is producing, without overt manipulation for presentational purposes.

Spend time talking to interim FDs, investigators from professional firms and turnaround managers and you hear stories of incompetence which often break through to the public domain. Many FDs know there is too much ‘value added’ and not enough ‘getting the numbers right’.