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When it comes to creative accounting, the public sector’s taking the

In the 1980s it was lawyers and the merchant bankers who were the main carriers of the creative accounting infection which swept through so many of the UK’s corporations. The accountancy profession has made a great deal of progress since those days and while creative accounting has never been completely eradicated it has been largely contained. However, if there is another outbreak then, instead of the rocket scientists in the City being the culprits, it looks as though the mandarins in the Treasury will be the ones bursting through the carefully laid accounting rules and principles of the last few years. Despite its poor reputation, the old Accounting Standards Committee (ASC) did produce the still extant SSAP21: Accounting for leases and hire purchase contracts. When the ASC published the standard in 1984, it did so in the face of fierce opposition from the legal profession. “When a company is leasing a substantial amount of assets instead of buying them, the effect is that unless the leased assets and obligations are capitalised, potentially large liabilities build up off-balance sheet; equally the leased assets employed are not reflected on the balance sheet,” the ASC said. “The omissions may mislead users of a company’s accounts – both external users and the company’s own management.” The leasing standard centres on the conflict between the practical substance of a transaction and its legal form. Many in the legal profession were furious that accountants had been allowed to place substance over form. The issue failed to flare up for two reasons: first, when the standard came into force in 1987 the tide of opinion was already turning against the extremes of creative accounting; and secondly, the fuzzy distinction between operating leases (which do not need to be capitalised) and pure finance leases (which must be reflected in the balance sheet) meant companies still had room for manoeuvre. Fast-forward a decade and you find the ASC’s replacement locked in a remarkably similar battle over accounting for the use and ownership of assets, except not with the wide-boy elements of the banking and City community, but with Treasury-based civil servants. The Accounting Standards Board (ASB) is in the process of putting together an amendment to FRS5: Reporting the substance of transactions – which was issued in April 1994 before the Private Finance Initiative (PFI) became such an important part of government finance plans. PFI is complex and so is the accounting, but the assets and liabilities behind these contracts do exist and they should be recognised somewhere. The key accounting question, according to the ASB, is whether the purchaser in a PFI contract has an asset of the property used to provide the contracted services together with a corresponding liability to pay the operator for it; or alternatively, whether the operator has an asset of the property used to provide the contracted services or a financial asset of a debt due from the purchaser. If the purchaser (the government) has the asset then it should go on its balance sheet and correspondingly the liability would count towards the public sector borrowing requirement. In contrast, the Treasury believes PFI involves the provision of integrated services, that the property and service elements are necessarily interrelated in order to provide the outputs required. The public sector is interested in the service and so liabilities should be kept off balance sheet because they are passed to the private sector. Sir David Tweedie said: “It is crucial to ensure that those transactions that give rise to liabilities for the government are reported as such, so that parliament is not misled over the extent of the payments it is committed to make in the future. It is also important that private sector accounts do not portray a false position to shareholders and others interested in them.” The strict ASB view could scupper PFI, in which case Tweedie would be responsible for single-handedly destroying it. But the point of accounting and financial reporting is to reflect financial and commercial transactions, not drive them. In this case, the amendment to FRS5 would not shift the PFI risk, it would just recognise where it really lies. Some are even suggesting that the title of the amendment should not be The Private Finance Initiative but Accounting for service contracts. If the ASB gets its way then it will only be a matter of time before the ‘P’ in PFI means public as often as it does private. Otherwise, as the Scots ICA puts it: “In the private sector where there are a few services to be added to what is clearly a finance lease, companies may be able to take these finance leases off balance sheet and treat them as provision of services.” In such a scenario the whole financial reporting framework would be undermined. It is not only in the area of leasing that the creative accounting warning signs are flashing. Arthur Levitt, chairman of the US Securities and Exchange Commission, said, in a recent speech to the Inter-American Development Bank: “Good accounting standards produce financial statements that report events in the period in which they occur, not before, not after. This means there are no extra rainy-day reserves, no deferral of loss recognition and actual volatility is not ‘smoothed away’ to create an artificial picture of steady and consistent growth.” He said, for example, that he would expect a company insuring beach-front homes to report losses when there are unusually severe hurricanes and extra profits in the unusually calm years. But in this risk conscious era companies appear to be increasingly keen to examine a variety of instruments – part funding, part insurance – which gives them a fall-back position should the unpredictable or the unforeseen happen. Anything, it seems, rather than go cap-in-hand to the City and explain why the forecasts have not been met. As for PFI, the ASB should stick to its guns to ensure this area, which has traditionally been subject to abuse, does not again become the hunting ground for the creative accounting experts. Peter Williams is a freelance journalist.

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