I suspect most people have a favourite Groucho Marx quote. Mine is: ‘These are my principles, and if you don’t like them… well, I have others.’ There is no evidence that Groucho ever trained as an accountant, but this quote suggests that he would have made a great auditor.
I am generally a fan of principles-based accounting, as long as the principles are adhered to. As we have seen with cashflow statements and business combinations, principles also need a solid framework of rules. Some things are too important to leave to individual interpretation. It should not be possible to omit crucial information that any rational investor would want to see.
Paragraph 15 of IAS 1 states that financial statements should ‘present fairly the financial position, financial performance and cashflows of an entity’. Paragraph 10 of IAS 8 helpfully adds that in the absence of an appropriate standard, statements should ‘represent faithfully the financial position, financial performance and cashflows’.
In other words, these two paragraphs should provide an overriding principle that fairness and faithfulness trump all other considerations.
Many companies were withholding details from their shareholders
Hidden costs
I sometimes wonder whether these two paragraphs are excluded from the training that accountants undergo.
Before the pension accounting rules were tightened, it was often impossible to work out how pension costs ran through the income statement. In some regions, you couldn’t even work out the size of the pension deficit.
I remember helping to draft a letter to the Financial Times pointing out that this was a clear breach of IAS 1 and IAS 8. For many companies the costs and liabilities associated with their defined benefit pension plans were very material indeed, and yet they were withholding the details from their shareholders. The letter made its authors feel a little better, but had no other visible impact. Pension disclosure remained opaque until the rules changed.
It was obvious to me as a non-accountant that the accounts were neither fair nor faithful
In almost every case of accounting skulduggery that I have seen, there were two common themes. The first was that the house of cards was inherently unstable and eventually collapsed. As a CEO once said to me: ‘The problem with dodgy accounting is not the accounting itself, it’s the operational problems it’s designed to hide.’
The second theme was that after the event I always wondered how on earth they could get away with it. It was obvious to me as a non-accountant that the accounts were neither fair nor faithful. And yet they had been signed off by the auditor.
Maybe it’s just easier to police the small print than to enforce the big principles
Unfair view?
As far as I know, no auditor has ever been censured for failing to apply the fair and faithful override, although I would be very happy to be proved wrong on this. It seems to me that technical compliance is considered more important than the principle of fairness. Maybe it’s just easier to police the small print than to enforce the big principles.
There is a very important issue at stake here. I would love to inhabit a world where the lead audit partner felt empowered to say to a company: ‘This approach may be technically correct, but it is neither fair nor faithful. And on that basis, we refuse to sign it off.’
Maybe these conversations do indeed take place and are simply private; it’s hard to know for sure either way. And I would like this fantasy world to include a requirement for audit committees to investigate and report back on well-founded complaints that the accounts are unrepresentative of the financial health of the company.
But most of all, I want serious regulatory penalties specifically for failing to comply with these two really important paragraphs. Auditors should not be able to cite Groucho Max in their defence.
