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Quill pens at dawn?
In 2006, Richard Aitken-Davies set down some of his concerns about the direction of trends in accounting thinking as regards the 'stewardship' versus the 'modernist' protagonists. He voiced the concerns of many in the profession when focusing on some of the complexity that enters the standard-setting debate.
This may come as a surprise to readers who do not qualify as accounting anoraks, but controversy still rages among the accounting cognoscenti as to the purpose of accounts. This, more than 500 years after double entry book-keeping for recording financial transactions was first documented by Luca Pacioli, the father of accountancy, in 1494.
Yes, there is a fundamental divide on what might seem to the detached observer to be an obvious question. What are accounts for? The flames have been fanned in a recent discussion document issued by the International Accounting Standards Board (IASB), whose title somehow exemplifies the nature of the controversy (Preliminary Views on an improved Conceptual Framework for Financial Reporting: The Objective of Financial Reporting and Qualitative Characteristics of Decision-useful Financial Reporting Information). This is an exercise in advanced navel-gazing but, nevertheless, underlines what is a genuine divide in the profession.
In the traditionalists' corner are the 'stewardship' protagonists. These people, regarded by some as the recalcitrant vestiges of an old, disappearing world, believe that accounts are fundamentally a record of what has happened. For them, the focus of accounts is on translating economic activity for a given period of time into a readily intelligible, 'true and fair' quantitative record, in the currency of the jurisdiction in which the entity is headquartered. The principal purpose of the financial records is to call to account management for the stewardship of the entity by those who have a legitimate interest - the 'stakeholders'. These could be investors, creditors, owners or tax authorities.
In the opposite corner, the 'modernists' comprise a growing and very powerful force in the narrow world of accountancy regulation. Their view is that accounts are principally a tool for decision making. Not for them the boring old financial record of economic activity. They seek to place much greater demands on accounts, which they believe should provide a reliable indication of the future prospects for the entity in question - not only for existing, but also prospective, stakeholders.
The modernist lobby has, argue the traditionalists, imposed hugely increased demands on the preparers of accounts, injected a level of unhelpful sophistication, opened the floodgates to subjectivity and rendered accounts virtually unintelligible even to well-informed observers. IAS 32 and IAS 39, the notoriously arcane standards on disclosure and measurement of financial instruments, are examples cited by the traditionalists as the modernist approach gone mad.
The following example from a leading UK utility company's latest report and accounts show that the traditionalists may have a point: 'Futures, swaps and forward agreements are valued against the appropriate market-based curves. Forward price curves are developed using market prices from independent sources for liquid commodities, markets and products and modelled for illiquid commodities/markets and products.
'Single-variable options are valued against market price and volatility curves. Dual-variable options are valued against market price, volatility and correlation curves between two variables. Volatility curves are developed for open positions in both liquid and illiquid markets. They are developed from actively traded options (implied volatility), where markets exist, or using historical forward volatilities and other relevant market data. Correlation curves are developed using historical spot and forward correlations and other relevant market data.'
How much sense will this make to the average reader? In this report, the accounting policies and definitions took up 14 pages of closely printed text, while the notes to the financial statements run to 67 pages, including no less than 11 pages on Note 44, Summary of differences between IFRS and US GAAP. One wonders how we have arrived at a situation where a company with thousands of ordinary people as stakeholders can have an 11-page summary of a single point in the accounts.
The complexity of accounts is being exacerbated by the movement towards global convergence of accounting standards. Major strides have been made by the IASB, with countries in the EU and around the world signed up to the adoption of International Financial Reporting Standards for listed companies. Moves are also afoot to seek convergence with the far more prescriptive, rules-based accounting standards applied in the US. The process of negotiation and compromise aggravates the degree of complexity of the resulting common standards. Additionally both the international (IASB) and US (FASB) protocols are firmly in the hands of the modernist movement to the obvious discomfort of the traditionalists.
Where does ACCA stand in this debate? Somewhere in the middle-ground between the traditionalist and modernist extremes, with a slight leaning to the stewardship view. We recognise the value of accounts to decision makers but worry about the consequences of over-elaboration of accounts on intelligibility and reliability. We are concerned that standard-setters may be placing undue emphasis on the value of accounts as input into decision making rather than their integrity and intelligibility as a financial record.
We favour global convergence but are alarmed by the potential demands on small and medium-sized enterprises (SMEs) of having to adopt complex and costly requirements of an international protocol designed for large listed companies. That is why ACCA has put considerable emphasis and trust in the IASB to come up with a streamlined version of IFRS for application by non-listed entities. This project is under way and an exposure draft of the proposed standard, equivalent to the UK’s Financial Reporting Standard for Smaller Entities (FRSSE), is due shortly.
Even for larger entities with the resources to digest and comply with IFRS, we believe that fresh thinking is required. We therefore welcome the move to review and consult upon the conceptual framework for accounts so that these fundamental questions can be addressed. Pacioli would surely approve.
What's your opinion?
Now, two years after Richard Aitken-Davies wrote this article, his opinion has even greater topicality in the current credit crisis, and the debates over fair value, mark to market, and mark to model. He asks the fundamental question, what are accounts for? Do they serve as a record of what has happened in an organisation? Or do they have a role to serve as a tool for decision making?