A couple of years ago an accounting academic remarked that audit was “busy, useless work”. His remark stemmed from the thought that one should never mistake activity for productivity. In other words, while it is clear that the process of audit creates a lot of work it is less certain whether it creates any value. Having witnessed the activities of the world’s financial markets this autumn, it is tempting to describe the whole global financial reporting system as busy, useless work. Despite the efforts of financial reporting standard setters to bring both the content and timing of financial reports more closely into line with economic reality, in a fast moving financial crisis their efforts look like so much wasted space. While markets are jogging along, financial reporting seems a valid exercise. However, the recent stockmarket gyrations, the financial crisis in Russia and the uncertainty in the Far East appear to have rendered financial reporting irrelevant. In time of economic stability and growth, the financial reporting industry is promoted as a vital cog in the working of free markets. Although, admittedly, not the most glamourous part of the machinery, the standard setting, measuring and reporting are deemed vital for both professional and private investors to make informed decisions about individual companies and their finances, as well as differing sectors and markets as a whole. That, at least, is the theory. Why else should countries such as the UK have worked so assiduously to make huge strides forward in its financial reporting systems in the 1990s? Why should some of the best accountancy minds across the world be spending so long trying to stick together a deal with the world’s stock exchanges to make accounting and reporting standards comparable and interchangeable across any bourse in the world? For the vast majority of companies, the panic in the market has broken the sane and logical link between the actual underlying value of the shares as derived from – in part, at least – the statutory financial information and the actual price of those shares in the market. Perhaps only banks and other financial stocks really deserve the hammering that they received. After all, who knows what financial losses are waiting to be revealed when their prelims are announced in a few months’ time? At this stage it is likely the directors themselves don’t know the extent of the damage. However, many companies’ directors clearly think the fall in their share price has been overdone. Indeed, some companies – notably ICI – have put out statements to the effect that the share price no longer reflected the worth of their business and the commercial reality which they were experiencing. The global crisis has opened up the ever-present tensions between the City and boards of directors. One FD of a support service company was curious why his company had been labelled as a cyclical stock when he and his board were confident it wasn’t. Another FD who had just been involved in raising funds slammed the City for never reading the small print and seemingly not understanding the finer points of his company’s finances. This is where the City and FDs will forever diverge. FDs work on analysing facts and data. In contrast, the City enjoys working – and maybe surviving on – gossip and rumour. A former FD who now runs a City risk consultancy said that several weeks prior to the collapse of Long Term Capital Management (LCTM), he was told by someone in the City that they understood the total exposure of this fund was “several billion”. In the subsequent weeks this rumoured exposure figure changed constantly and dramatically. Eventually the rescue amounted to $3.75bn. The risk consultant sums up the market view of reports and accounts when he scoffs that they are “a waste of paper”. LCTM is just one example of the financial markets trying to digest what happened. In contrast, the financial reporting time-frame makes the information when it finally emerges just so much ancient history. And there is nothing that can be done to change the reporting cycle. The Accounting Standards Board may be asking companies to publish their prelims within 60 days but the idea of more frequent reporting through the Internet is a non-starter. Some involved in financial reporting remain resolutely relaxed by their role being cast into irrelevance. One audit partner in a Big Five firm pointed out that financial reporting probably had played a bit-part in the early days of this turmoil. Poor financial reporting in Russia and, to a lesser extent, in the Far East played some part on triggering the crisis in those markets. Accounting standards which are not as rigorous as those enjoyed by companies in the West helped investors to lose confidence as they realised they could not fully trust the numbers. Otherwise, corporate reporting is no more than a spectator as markets and companies rise and fall as a natural consequence of the capitalist system. Companies, such as ICI, have a right to reassure the market and the proof, or otherwise, of their assurances will be delivered when the figures are published. Financial reporting provides the long-stop basis of information upon which investors can make judgements. Just before the stockmarket crisis gained momentum, earlier in the autumn, the ICAEW had called for a major review of financial reporting. According to the Institute, corporate reporting is at a crossroads. Issues such as globalisation, information technology, developments in corporate governance and the increasing importance of intellectual capital are all raising “fundamental question” about how companies report on their performance. When the Institute called for a broad review of corporate reporting encompassing a wide range of “stakeholders” it could never have imagined the commotion which was about to break in the financial markets. If corporate reporting is at a crossroads, the question must be how to embark on the road towards relevance? Don’t expect any quick answers. Peter Williams is a freelance journalist.
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