Executives have a big decision to make about the way they report their companies’ financial performance as the resurgence of Covid-19 plays havoc with forecasts.
They can use the pandemic as an excuse for weak performance and rising indebtedness; they can procrastinate and stick with former assumptions; or they can be honest about the company’s weaknesses, including that it may need refinancing to survive.
This dilemma is exacerbated by Covid-induced recessions, but it is not new. Companies are often under pressure to report what users of accounts want to hear, rather than the unvarnished truth.
At the end of last year, General Electric agreed to pay US$200m to settle charges from the US Securities and Exchange Commission that it misled investors over profits and cashflow in its power business, and liabilities in long-term care insurance. The disreputable methods included cutting projected claim costs and generating cash through internal transactions.
Scope for manipulation
John T Dugan, associate director of enforcement, said: ‘Companies like GE, with complexities such as interdivisional transactions and reliance on estimates of future costs and revenues, must ensure that the information they provide to investors is not misleading’. His comments unintentionally also point to the scope for manipulation.
Covid has broken many crystal balls that should never have been relied on in the first place
Another recently published document to shed light on dark practices is the report of a UK disciplinary tribunal on findings by the Financial Reporting Council against Deloitte over its audits of Autonomy. The firm was fined a record £15m.
Amid much detail about the decade-old misreporting of hardware purchases and sales, a telling point is Deloitte’s awareness that ‘The Group’s share price is extremely sensitive to changes in revenues which are outside market expectations.’ The same went for gross margins. It was in these accounting areas that the rule-breaking went on.
Never mind the long view
Pressure on Autonomy’s management came from too much good news. Now the pressure valve is being turned up in sectors such as hospitality and travel by the malign twists in news about the pandemic.
If companies are to be totally open and honest, the first type of external pressure they need to resist is to give a long view of their resilience. The ‘going concern’ basis for accounting now comes into its own. It records the simple fact that the company is still going, looking ahead 12 months is sufficient, and any material uncertainties about that must be declared.
Telling it how it is means being clear about the assumptions behind those estimates, whether these are about external conditions or internal weaknesses
The demand from some users of accounts that companies more or less guarantee that they will still be in business in three or five years’ time is unreasonable. Covid has broken many crystal balls that should never have been relied on in the first place.
Mary Tokar, board member at the International Accounting Standards Board (IASB), and Sid Kumar of the IASB’s technical staff, point out in an article published in October that ‘an actual outcome that differs from an estimate is likely in times of heightened uncertainty and does not mean the estimate was an error’.
Telling it how it is means being clear about the assumptions behind those estimates, whether these are about external conditions or internal weaknesses.
