Accounting standard setters are trying to face down
continuing pressure from politicians to ensure accounting standards contribute
to global financial stability. Alongside the main G20 communiqué published in
April, an annex, Declaration on strengthening the financial system, states, “We
have agreed that accounting standard setters should take action by the end of
2009 (within the framework of the independent accounting standard setting
process) to improve involvement of stakeholders, including prudential regulators
and emerging markets, through the IASB’s constitutional review.”
The IASB is determinedly relaxed about the call of the world’s leaders to
help create stability. But others are equally determined to warn politicians and
regulators in more forthright tones about the dangers of muddying the waters
over the primary purpose of financial statements. Maybe Paul Boyle feels less
restrained now he has announced he will step down as chief executive of the
Financial Reporting Council.
A speech given by Boyle as the G20 bandwagon rolled into London delivered a
clear warning to politicians not to pervert the use of reports and accounts.
While financial statements are designed for various end-users, there are special
users – such as tax authorities and financial regulators – with legal powers to
compel companies to provide them with the information they require. As Boyle
puts it, they can insist on tailor-made suits while most of us have to get by
The present financial reporting product, shaped by the application of
accounting standards, is unsuitable for raising taxes or determining how prudent
a bank should be in its lending practices.
While Boyle acknowledges that politicians have a responsibility to ensure
there is an effective system for setting accounting standards, he says the
choices as to the most appropriate accounting methods should not be made on
political grounds, but rather, by standard setters free of all vested interests,
relying on their skills and experience. If the purpose of reports and accounts
was to be significantly diverted to a financial stability role, there would be
implications for the current use of accounting that would need debating.
Of course, there are good reasons why the IASB can’t be quite as outspoken as
financial professionals might wish. Since this current financial crisis emerged,
it has had to engage with panicked world leaders working on a list of demands
since the previous G20 in Washington in November 2008, as well as dealing with
the Americans who have had a mini-crisis over whether to keep on with their
‘roadmap’ to global standards. While the rhetoric may differ, the IASB shares a
determination not to let the reporting and recording of regulatory capital be
confused with accounting capital.
Accounting standards cannot be allowed to return to a situation of profit and
loss smoothing and poor disclosure. That shouldn’t stop regulators from
demanding financial institutions should have capital requirements over a level
of non-distributable reserves and rules over the size and timings of capital
restructurings, such as share buybacks and dividend payments. But that should
not be confused with reports and accounts following cookie-jar accounting, when
a company uses generous reserves from good years against losses that might be
incurred in bad years. If that were to happen, it would be more difficult for
all users of financial statements to make meaningful assessments about the
performance of the company and the management. As far as the accountancy
profession is concerned, smoothing through the cycle is just not on.
However, the question is whether standard setters can fulfill the primary
role of reports and accounts – transparent communication of the current
financial position – while allowing those reports to be used to calculate and
demonstrate prudential capital requirements.
Boyle suggests one course that may answer the concerns of this ménage à trois
of politician, regulator and accounting standard setter. Standard setters have
been under constant political pressure for the past four years to abandon fair
value accounting because it was giving the “wrong” answer, with assets worth
more than the market says they are. The irony is, argues Boyle, market prices
have indeed been wrong, only the assets are proving to be worth even less than
the market first indicated. His answer is to consider whether investors would
find it useful to have disclosure of both market and model valuations.
Given the uncertainty around the valuation bases, investors would be able to
assess which is the more reliable measurement basis. This could be done, for
example, by requiring the disclosure in subsequent years of the difference
between the proceeds for assets which have been sold and the market and model
valuations at the previous year-end.
Whatever the merits of Boyle’s suggestion, the IASB is quietly confident it
can make a contribution. It does have a delicate path to tread. However, there
is already too much uncertainty in the global financial system over issues such
as ‘toxic’ assets. Increasing uncertainty would be folly. So the key point
remains: any attempt to curb accounting transparency must be resisted.