Accountants and the crisis: standard setters – troubled waters

As the storm clouds of recession gather, the role of government and
regulators in keeping the economy from toppling off a cliff comes under immense

Pre-Enron, the role of accounting standard setters seemed almost irrelevant
to the performance and health of the real economy. City analysts were more
interested in cashflows. Strong cashflows equated to good profits and high
valuations. Apart from the cashflow statement, the rest of the financial
statements seemed an irrelevance to many shareholders in the quoted sector of
the economy.

But the cashflow statement was a late arrival in company financials compared
with the balance sheet and the profit and loss account.

A cashflow standard was issued in the early 1990s, replacing the unlamented,
unmissed and frankly baffling, funds flow statement. But the relevance of
accounting standards now stretches far beyond ensuring accurate reporting of
company cashflows.

As accounting standards attempted to respond to an increasingly complex
economy, disputes with those who saw the attention of standard setters as
unhelpful were inevitable. One of the key objectives of financial reporting ­ as
stated in numerous attempts to work out a conceptual framework for accounting
standard setting ­ is to provide information that is useful in making business
and economic decisions.

The words come from the US standard setter
FASB, but are echoed by other
boards. Behind that motherhood and apple pie statement lie a whole host of other
questions. For whom is the information intended? What type of ‘business and
economic decisions’ do they make? What information do they need to enable them
to make those decisions?

The FASB statement goes on
to to say that ‘financial reporting should provide information to help
investors, creditors and others assess the amounts, timing and uncertainty of p
rospective net cash inflows to the related enterprise’.

The history of standard setting over the past two decades has been a fight to
provide that information and for relevance. Standard setters have seen a
complete lack of rules covering key economic activities (financial instruments
is the classic example); rules that were irrelevant (pension accounting springs
to mind); or were so loose that any self-respecting management (along with their
advisers) would be mad not to drive a coach and horses through them. The rules
on business combinations fit that bill with ‘big bath provisions’ where even the
most value-destroying deal could be cloaked in some accountability of
respectability, at least for the first couple of reporting seasons.

Standard setters have often battled on in the face of criticism. In 2002,
then work and pensions secretary Alistair Darling, attacked FRS 17 Retirement
Benefits, suggesting it was out of line with international practice and damaging
the defined benefit pension industry.

Present pension accounting may have critics, but few now argue that a
standard attempting to measure the true cost of a pension arrangement for
shareholders is worse that a standard that obfuscates, leaving future
shareholders, managers and employees to pick up the very expensive pieces.

Of course we should not pretend that accounting is neutral. By measuring the
numbers in a certain way it determines behaviour, which is why people seek to
change the accounting. By forcing the savage impairment of financial instruments
in the credit crunch many reckoned the standard setters were being over-hasty
and valuing great swathes of banks’ balances sheets at way below realistic

Suddenly accounting rules could stop being a technical argument between
clever accountants and start having a real impact. The
IASB may be sticking
to its fair value guns but significantly it is prepared to engage with the
financial services industry to see if it can refine or redefine the valuation

While standard setters stand accused of stoking the flames of the crisis by
their rules, could they also be accused of making this economic and financial
crisis worse by inaction? The UK’s Urgent Issues Task Force (part of the ASB)
has been looking at the legal definition of off balance sheet following
confusion prompted by the Companies Act 2006.

One major factor in pushing credit was the rise of special purpose vehicles
that allowed banks to keep certain things off their balance sheets. Much is now
back on, but if the accounting rules had ensured they had never left the balance
sheet in the first place, maybe the credit crunch tale would have been

If investors change their behaviour during an economic downturn should
standard setters? The IASB has made a great play about how it is responding to
the credit crisis by joining with other regulators in keeping financial systems
and markets working. Should standard setters change their agenda by working with
other regulators and companies to help restore confidence in markets?

One of the big battles left to fight in the standard setting world is
leasing. Is now the right time to drive billions of dollars of aircraft, rolling
stock and other fixed assets back on to corporate balance sheets?

Standard setters don’t determine whether economies prosper or fall into

They help to sort out the rules that determine the score. But when
livelihoods and fortunes are at stake, it is perhaps not surprising that
accounting standard setters become another victim of messenger shooting.

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