View Point

David Myddelton, professor at Cranfield School of Management, believes regulators should scrap recent accounting changes. This Viewpoint is based on his recent book, Unshackling Accountants, published by The Institute of Economic Affairs.

 

 

 

Accounting Over-Regulation: Why Reinforce Failure?

In the last 10 years the quantity of accounting law and regulations has risen by 150%, from about 800 pages to more than 2,000. Since 1991 the 20 new Financial Reporting Standards have averaged 85 pages each. The latest volume of International Financial Reporting Standards comprises 2,250 pages. But all my generation of accountants had by way of regulation was a mere 26 pages in the 1948 Companies Act relating to accounts and audit.

I believe this will all end in tears if we don't do something about it very soon. Hence my own suggestion that we should scrap the lot, save only a single sentence in the Companies Act requiring company accounts to give 'a true and fair view'. That would leave accountants and auditors free again to exercise their own subjective professional judgment.

What a contrast with the present situation, when accountants have to pretend to hold opinions which in fact they don't. That is because the revolutionary new statement of principles, based on 'decision-usefulness,' is not 'generally accepted.' Actually most accountants still prefer the prudent matching approach based on the traditional notion of 'stewardship.'

There are at least two serious problems with the new approach, which most standard-setters, if few others, accept. First, it will lead to much greater volatility in the annual interim accounts of many companies, which in the long run will make it harder to understand what is happening. Second, it is based on the flawed notion that it makes sense to use current 'market' values even when there is no genuine market for the assets and liabilities concerned.

The flood of over-regulation has falsely raised expectations about the possible accuracy of company accounts. In fact, as a moment's reflection should make clear, it is extremely ambitious to attempt to summarize once a year the complex affairs of modern companies in a mere three financial statements, even supplemented by many pages of notes.

In a going concern, many transactions are incomplete at the balance sheet date, so to a great extent the annual accounts have to contain estimates rather than definite facts. But in making estimates about the uncertain future there are few uniquely 'correct' answers and competent people may honestly hold different views. Moreover many important aspects of business cannot be quantified at all, such as employee morale, customer satisfaction and management expertise.

Much of the impetus behind standards comes from the quest for 'comparability' between the accounts of different companies. But there may often be more than one possible way to account for transactions. We are entitled to expect each reporting entity to say which method it has chosen, and to stick to it consistently. But comparing the accounts of different companies is likely to be far more difficult, if not impossible.

The path to so-called 'international harmonization' (or 'global monopoly', as I prefer to call it) is by no means straightforward, as it seems quite possible that the European Commission will fail to endorse all the International Accounting Standards. I find myself unexpectedly in sympathy with President Chirac, whose banking constituents object to IAS 39. This is not a technical accounting issue, but a highly political one: should accounting principles be 'generally accepted' by the accountancy profession or should they be imposed by a body of experts?

Recent accounting scandals, in the U.S. and elsewhere, are said to have damaged confidence in the accuracy of company accounts. If so, that is indeed good news! People seem to expect far too much from accounts, hence reducing overconfidence may help to limit ultimate disappointment. Perhaps each set of accounts should carry a 'health warning,' like packets of cigarettes?

But the Sarbanes-Oxley Act was rushed through in 2002, in a classic knee-jerk reaction, to 'tighten up requirements' in the United States (at enormous expense to companies). As so often when regulation falls short of what it promises, the 'solution' is to reinforce failure by more of the same. Accounting scandals have always been with us, and always will be. Anyone who thinks over-regulation is the answer is ignorant of history.