Tax Research UK

FT.com / UK - FSA on defensive over Lehman failings.

Good to know I got yesterday’s musings on Lehamn right.

As the FT reports:

UK financial regulators said they had no reason to question the so-called “accounting gimmick” used by Lehman Brothers to flatter its results because the investment bank’s UK subsidiary’s reports accurately reflected the transactions.

Why - because they were correctly reportted on balance sheet under UK GAAP here.

But as they also note:

In the UK, the bank was able to get a legal opinion certifying that the transactions qualified as sales . Lawyers not connected to the transactions said the UK’s definition of sale is slightly less restrictive than the relevant law in the US.

The legal opinion made no difference to the Lehman UK subsidiary’s accounts to the FSA because they were made under UK accounting rules, which require both repos and sales to be reported on the balance sheet, the FSA said. But when the UK accounts were consolidated back to the US, under US accounting standards, known as GAAP, the transactions disappeared off Lehman’s balance sheet, the Valukas report said.

“The balance sheet effect referred to in the Lehman report only occurred in the consolidated accounts which were prepared under US GAAP,” Mr Sants [of the FSA] said.

“This is a matter for US financial reporting standards, not . . . for UK supervision,” he said. “This is arbitrage between US accounting rules and UK law.”

This is exactly as I suggsted.

But Hector Sants is wrong because if accounts can be abused in this way of course it is an issue for UK regulators.

So this should be high on the FSA agenda when its continued existence is confirmed after the election.

Richard Murphy Accounting, Auditing, Banking, Regulation

Prem Sikka is in the Guardian saying:

The Lehman insolvency examiner’s report once again shows that the public should be sceptical of the audited accounts published by giant corporations. Accountants disarm journalists, critics, regulators and the general public by claiming that the accounts are fairly presented in accordance with some generally accepted accounting principles (GAAP), but the Lehman report shows that they are based in carefully rejigged accounting practices (CRAP).

He’s expanded on my theme.

Good man.

Richard Murphy Accounting

There’s much discussion today about whether the alleged professional negligence by Ernst & Young with regard to the audit of Lehman Brothers – where it appears they turned a blind eye to the rigging of the balance sheet – might be their Enron and lead to the demise of the firm.

I’m on record as saying I think the end of at least one of the Big 4 is nigh – and with it the whole audit market.

But let’s be clear – Ernst & Youngs’ defence – that their audit complied with US GAAP (Generally Accepted Accounting Principles - pronounced ’gap’) may be true. But that’s not the point. The point is US GAAP is crap and the Big 4 engineered that their audits do not need to report either truth  or fairness.

As the rules of the IAASB (International Auditing and Assurance Standards Board), which sets auditing standards  says, an audit is:

The purpose of an audit is to enhance the degree of confidence of intended users in the financial statements. This is achieved by the expression of an opinion by the auditor on whether the financial statements are prepared, in all material respects, in accordance with an applicable financial reporting framework. In the case of most general purpose frameworks, that opinion is on whether the financial statements are presented fairly, in all material respects, or give a true and fair view in accordance with the framework. An audit conducted in accordance with ISAs and relevant ethical requirements enables the auditor to form that opinion.

The wording is not a chance: the emphasis is on compliance with the financial reporting framework first; the consequence of being true and fair is assumed to follow, but is consequential, not the goal.

So, E & Y influence the International Accounting Standards Board that sets the framework.

And they influence the IAASB which limits the scope of the audit to the point it’s useless.

And although financial statements are meant to be produced for the benefit of the providers of capital to a business (in itself far too narrow a requirement) the auditors in the UK (by reason of the Caparo decision) and in the US under Delaware law basically can’t be sued by those providers of capital.

In other words the auditors charge a lot for doing a job badly for which they know they have almost no liability. It’s not surprising they don’t really care.

It’s not E & Y who have erred here – it’s all those who let this situation develop that have erred. The accounting structures we use are rotten to the core and so is auditing. Unless both are reformed we are heading for collapse after collapse after collapse as the prevailing mood of society to promote expedient short term greed will destroy entity after entity without any check or balance in place to stop it happening.

This can be tackled.

It needs to be tackled.

Without the political will to tackle it just watch society collapse like a pack of dominos as big business begins to fail all round us.

And I think I’m underselling the melodrama in saying that.

Richard Murphy Accounting, Auditing, Big 4, Ernst & Young, Ethics, IASB

I do seriously wonder of the concept of limited liability has reached the end of viability.

Two examples have made me ponder this weekend. The first is the tale of Iceland where the people of that state have voted by 93.1% to not accept liability to the UKI and the Netherlands for debts due by failed banks registered in their state. The UK and Netherlands have bailed out those depositors. Now they want the people of Iceland to repay them even though the banks in question had limited liability. And they have said no, they can’t wand won’t pay. I happen to think they’re right to do so. The UK and Netherlands should have regulated sales into their states, but more importantly, people who have no link with a bank are not liable for its debts. If they are, then the concept of the company is radically transformed.

Second is the tale of the UK’s private / public partnership to upgrade London’s tube line. This has failed in all but name. As the Guardian notes:

An exchange of letters between LU, the government and the PPP contract referee, seen by the Guardian, indicate that the publicly owned tube operator will have to make multimillion-pound spending cuts, raise fares or cut back on network upgrades to plug a £400m funding gap in the troubled contract with Tube Lines – the last surviving PPP contractor.

Again the message is clear: the private sector fails and the bill is picked up by the state.

Several important things become clear.

First, banking cannot just be a domestic regulatory issue.

Second, small states can’t regulate banks operating internationally. Actually, that extends to financial services as a whole.

Third, apparently limited liability is in these situations meaningless: we are all providers of capital, whether we know it or not.

Fourth, in that case the relationship between companies and those who engage with them has to be radically transformed. This transformation would involve a reappraisal of what capital is, who provides it and what the duty to report might be. What is quite clear is that the providers of capital in the cases noted are not the shareholders, conventional lenders or even recorded creditors. The International Accounting Standards Board says that the users of accounts (which they use as a proxy for those with interest in companies) are:

The primary user group includes both present and potential equity investors, lenders, and other creditors, regardless of how they obtained, or will obtain, their interests. In the framework, the terms capital providers and claimants are used interchangeably to refer to the primary user group.

Well in that case we are all providers of capital to many companies. How does that, then, change the perception of reporting?

This is a key issue and the professions aren’t engaging with it.

Why not?

Richard Murphy Accounting

As the Guardian notes:

Politicians from the three main parties and football supporters’ groups have united in calling for the Football League to make public who owns its clubs after the league approved as "fit and proper" the offshore owners of Leeds United while keeping their identity private.

The sports minister, Gerry Sutcliffe, said: "Fans of any football club have a right to know who the owners are. We want to see greater supporter representation in the running of football clubs and far greater accountability. The League should insist on clubs making public to their supporters who owns them."

He was joined by the Conservative shadow sports minister, Hugh Robertson, who argued: "As with Parliament and many other areas of public life, transparency is going to be an increasing requirement and expectation. That includes publicly identifying the owners of football clubs. Football should reform its governance, to include greater supporter representation on the board of clubs."

That call was echoed by the Liberal Democrat MP for Harrogate, Phil Willis, who has long criticised the anonymity of Leeds’ ownership, routed via companies in offshore tax havens. "At the very least, supporters of a club have a right to know who owns it. As an act of faith and goodwill, I hope the Leeds United board now publish the documentation they have presented to the Football League so that all sense of mystery can be removed."

The Premier League does now require its clubs to publish the names of all shareholders with stakes of 10% or more, but the Football League does not. Instead, clubs must tell the League’s chairman, Lord Mawhinney, and three other senior executives, who the ultimate owners are, but the information is not made public.

I applaud all three parties for their observations, but think its time they went much further.

It is very obvious that we now need the following on public record with regard to all and every company, trust, partnership, LLP, charity and other entity created under law in the UK, and with regard to all business and trading names used in the UK so that anyone anywhere can be sure with whom they are trading:

1. The names of the real human beings (not nominees) who are the ultimate beneficial owners of more than 5% of the entity (related parties to be aggregated to come to the figure) and if there are none the names of those who established the trusts that created that situation and those who have benefited in any form from those trusts in the last ten years unless that was charitable;
2. The full names and addresses of all directors, partners, settlors, trustees, enforcers (yes, trusts have them), and other statutory officials who mange these entities;
3. The full accounts (not abbreviated) of all accounts that enjoy limited liability;
4. The address where each of these persons is resident – nominee addresses not allowed.

And we need a competent legal authority to pursue this.

It’s a sad fact that in the UK Companies House is just not interested in doing so.

Then we’ll have transparency. And it’s very obvious we need it.

Richard Murphy Accounting, Secrecy jurisdictions, Tax Havens

PWC issued the latest of their Total tax Contribution reports today.

I readily admit I do not buy the logic of these reports, but this is what they say:

A survey by The Hundred Group of FTSE 100 Finance Directors has found that the UK total tax rate – combining all taxes borne or collected by FTSE 100 businesses on the Government’s behalf – has grown significantly as a proportion of total corporate earnings since 2007.  

The members of The Hundred Group reported that their total tax rate increased from an average of 38.2% of total earnings in 2008 to 41.6% in 2009. This represents a year-on-year increase of 9% in FTSE 100 companies’ average total tax rate; an expansion in the overall corporate tax burden which has been implemented against the backdrop of the deepest recession for many years. 

The survey was conducted on The Hundred Group’s behalf by PricewaterhouseCoopers LLP.  During the 2008/2009 tax year, the UK’s largest companies paid or collected £66.6 billion in taxes. Corporation tax payments fell 6.4% to £10.3 billion over the period. However, other taxes did not reduce in line with declining profitability and therefore account for a higher proportion of overall earnings. 

But hang on – don’t economists all agree that business can’t pay tax?

How can so many people – the captains of industry and the biggest firm of accounts in the world no less – have made such a drastic mistake in the face of that evidence from the world’s best economists (you know, the ones who didn’t see the recession coming)? Note that PWC say borne? Surely some mistake?

I hope Tim Worstall’s on the case

Richard Murphy Accounting, PWC

Accountants could be next for tax amnesty - Accountancy Age.

The Age notes:

Fresh speculation surfaced over the weekend that accountants could be the next profession to be offered a tax amnesty, according to reports in in the Mail on Sunday.

HMRC is currently running a new disclosure opportunity for the medical profession but the press have speculated that accountants, lawyers and construction company bosses could be the next to be targeted

Let me suggest what a tax amnesty for accountants should be:  three years instead of four at HM’s pleasure, I think.

Richard Murphy Accounting

John Kay discusses this issue in the FT and concludes when comparing historic cost and mark to market accounting:

We are dealing with questions to which there are no right or wrong answers. The true and fair view is subjective, and no accounting principles, however extensive, can cover all conceivable situations. The appropriate measure always depends on the purpose for which accounts are properly to be used. The only certainty, however, is that these proper purposes do not include flattering the egos of corporate executives or enabling banks to take deposits on false pretences.

The reality is both simple and obvious: the one view of the corporation that does not matter to the third party is the corporation’s view of itself. This is what we’re given, but that’s the spin. The reality is we want to know the risk it poses on us by engaging with it. That’s the bottom line.

If that’s the case then the International Accounting Standards Board argument on the whole issue of standard setting is wrong.

back to the drawing board then.

Richard Murphy Accounting, IASB

FT Alphaville » IASB softens on convergence.

The International Accounting Standards Board would no longer pursue convergence with its US peer as “an objective in itself”, its oversight body said on Monday, in a fresh sign of waning consensus on accounting rules. The IASB, which sets standards for most of the world outside the US, was nominated by the G20 to oversee development of a single accounting standard by mid-2011. But regulators and accounts say that politicisation of the accounting process will make it hard to achieve convergence of US and international standards.

So notes the FT. But it fails to note a lot in the process.

Most importantly, what it fails to note is that accounts are always political statements. No one can pretend otherwise. Capital is treated as meritorious, for example; labour is a cost to be minimised. Spending on replacing labour with plant and machinery is treated as creating an asset of value - the labour is just a loss offset. The whole process is value laden - as is the absurd claim by the International Accounting Standards Board that the only significant users of accounts are the suppliers of capital - a category that, as far as they are concerned includes labour until paid hereafter they have no interest in their employer at all.

So let’s stop the nonsense about politicisation - you could not get more political organisations that the International Accounting Standards Board, PWC, Deloitte, Ernst & Young and KPMG, let lone the Institute of Chartered Accountants in England and Wales.

The reality is we need this process politicised: we need accounting disclosure back under democratic political control where it does belong undertaken in the public interest. And if the professions can’t deliver they need to step aside and let the process be done properly.

Richard Murphy Accounting, IASB

FT.com / Companies / Banks - Deloitte chief reignites accounting debate.

The debate on how to account for banking losses goes to the core of International Accounting Standards project.

Now Deloitte and PWC cannot agree on the issue,a s the FT notes:

Jim Quigley, global head of “Big Four” accounting firm Deloitte Touche Tohmatsu has proposed that banks account for losses in two radically different ways, to meet the opposing demands of politicians and accountants.

He has told the Financial Times that he is an “advocate” of banks making loan loss provisions for “incurred losses” separately from “expected losses” – and reporting them in two different lines in their accounts.

However, PWC says this proposal would:

“muddy the waters”.

Politicians and regulators have blamed the current system of “incurred losses” – whereby companies may make provision for loan losses only as they occur – for exacerbating the crisis, by encouraging a cyclical approach to risk management.

But that view is questioned by many accountants and bankers who argue that “incurred losses” give investors clarity. Accountants and bankers are also are sceptical about the “expected loss” model, as they fear it raises the risk of “cookie jar” accounting, whereby executives put funds aside during years of bumper profits only to release them later to cover up bad performance.

Let’s be clear about this: until 2005 everything PWC are arguing for would have been unacceptable in the UK. We did expected loss accounting under UK rukles. It is only the International Accounting Standard Board that over-ruled this.

Three years later most banks fell over.

And the thing PWC is arguing against is anti-cyclical provisioning to ensure capital retention. To put it anothjer way, PWC wants pro-cyclical accounting that encoruages recklessness.

PWC’s recklessness seems to know no bounds. The lack of honesty in their argument is also stunning: to suggest that the prudence that under-pinned accountancy for more than a century is “cookie jar” accounting is an appalling mis-statement of reality. That prudence served us well and is exactly what we need now.

PWC needs a rude awakening.

Richard Murphy Accounting, Banking, Deloittes, PWC