Auditing » Tax Research UK

The House of Lords are incredulous: of course International Financial Reporting Standard

Accountancy, Accounting, Auditing Comments Off

Jun 162011

The House of Lords recently undertook a review of the role of auditors in the run-up to the 2008 financial crisis. The report was damning, and rightly so.

Now the government has responded and the House of Lords aren’t, overall enamoured with the response. As they note, in particular:

We were surprised by the Government’s denial that IFRS accounting standards had reduced prudence in audit. The Committee’s report concluded that IFRS has limited auditors’ scope to exercise prudent judgment. Auditors’ traditional, prudent scepticism must be promoted, whatever the accounting standards.

Too true: and it will get worse, as I have explained today.

Who is to blame for Ireland’s crisis? Easy: they need to sue KPMG, PWC and E&Y

Auditing, Big 4, Ireland 6 Responses »

Apr 012011

Ireland’s banks are bust.

They were foreseeably bust a long time ago. The failure is spectacular by any standards.

The accounts of Irish banks had to be wrong when signed off at the height of the boom. They were imprudent.

Who signed them off?

AIB – KPMG

Bank of Ireland – PWC

Anglo Irish Bank – Ernst & Young

Irish Nationwide – KPMG

Irish Life & Permanent – KPMG

Why are no writs being issued?

Let’s be clear – these banks failed to anticipate losses using reckless mark to market procedures that ensured they failed to comply with requirements that capital was preserved to protect creditors – the fundamental duty of all companies (over and above any duty to make a profit). The auditors were complicit in that in falling to identify the conflict between accounting requirements and company law – which in this case is the same for all practical purposes in Ireland as it is in the UK – where the same neglect took place, as the UK’s House of Lords made clear this week.

So sue, I say.

What have the Irish got to lose?

GE, KPMG, spin and tax avoidance

Auditing, KPMG, Tax avoidance 3 Responses »

Mar 302011

I blogged about GE’s US tax affairs, and the European dimension to its tax lobbying at the weekend.

I was not alone. It’s fascinating to note that GE seems to have taken exception to some of the commentary – but that according to the Huffington Post did so on Twitter. It’s an interesting new use for that medium. And, as they note, the effort seems to have pretty much failed. The reason? It seems they resorted to the standard (shall we call it the Barclays or OWC?) tactic of saying they’d paid lots of tax – $2.7 bn in all. But as the Huffington Post notes:

The dispute: what kind of taxes constitute that $2.7 billion GE claims to have paid? @khivi tweeted “@Gepublicaffairs tweets confirm @nytimes that GE paid $0 corporate tax,” to which GE responded “They are separate. Of $2.7B income tax paid, signf portion was US fed. GE also paid $1B+ in payroll, state & local use & property tax.”

You’d have thought they’d have realised that claiming you pay your employees tax which is their liability and not yours is a ruse that’s worn thin now – but apparently not.

More interesting comment came from Francine McKenna in her Forbes blog, where she kindly quotes me (we’re something of a mutual fan club) and then points out the role of LKPMG in this:

It’s not surprising that GE uses their auditor, KPMG, to help them put their “zero” tax return together.

The Sarbanes-Oxley Act of 2002 started out tough on tax. The rules regarding prohibited activities by the auditor, intended to preserve their independence, scared the living daylights out of the largest firms. It appeared initially that the SEC would prohibit the tax side of the firms from providing highly lucrative tax advice to their audit clients. Many of those professionals started planning an exit from their firms so they could continue working with long time clients.

A compromise was reached. The result is one of the loosest and most generous exceptions to auditor independence rules on the books.

The Commission reiterates its long-standing position that an accounting firm can provide tax services to its audit clients without impairing the firm’s independence. Accordingly, accountants may continue to provide tax services such as tax compliance, tax planning, and tax advice to audit clients, subject to the normal audit committee pre-approval requirements under 2-01(c)(7).

The Sarbanes-Oxley Act of 2002 also prohibits an auditor from providing “bookkeeping” services to its audit clients.

The rules utilize the previous definition of bookkeeping or other services, which focuses on the provision of services involving: (1) maintaining or preparing the audit client’s accounting records, (2) preparing financial statements that are filed with the Commission or the information that forms the basis of financial statements filed with the Commission, or (3) preparing or originating source data underlying the audit client’s financial statements. Our experience with this definition demonstrates that the concept of bookkeeping and other services is well understood in practice.

In defiance of these provisions, KPMG – GE’s auditor – provides “loaned staff” or staff augmentation to GE’s tax department each year. These “temps” perform tasks that would be otherwise the responsibility of GE staff. Sources tell me KPMG employees working in GE tax have GE email addresses, are supervised by GE managers – there is no KPMG manager or partner on premises – and have access to GE employee facilities. They use GE computers because the software required for their tasks is GE proprietary software.

This type of “secondment” to an audit client is never allowed. KPMG should know better. KPMG was recently sanctioned by the SEC for a similar transgression involving their Australian office.

What the heck? No tax is paid. It’s worth the risk. Haven;’ we heard that before about KPMG? Will they never learn.

Yesterday the economics of the playground, today the verges of madness

Auditing, ConDems, Small business 7 Responses »

Mar 172011

I missed this letter in the Guardian on Tuesday from Philip King, CEO of the Institute of Credit Management, but it’s well worth noting:

The business secretary announced on 4 March that small firms will no longer have to produce independently audited accounts in a measure he believes will save 42,000 businesses £40m per year. I’ve always respected Vince Cable and have no doubt of his commitment to helping small business, but such a move demonstrates a naivety that verges on madness. I agree with him when he says that “one of the barriers to growth is the burden of regulation ‚Ä¶ it takes up time and stops business growing, and that means our economy does not grow”. That is why the ICM supports the reduction of red tape. But please can we understand that producing accounts is not “administration” and neither is it unnecessary red tape.

Far from helping small businesses, the move is more likely to damage a company’s access to credit, therefore restricting growth and in fact adding to their costs. The government needs to get away from this idea that reducing red tape will always mean reducing costs to small businesses. Businesses extend credit to one another based on the trust that comes from knowing that the company is financially viable, and one of the essential proof points is a set of audited accounts.

Banks too look to lend on the basis of sound financial data, so limiting the amount of financial information available will do more harm than good. The government must stop sending mixed messages. If it wants small businesses to drive the economy, this is not the way to do it.

Precisely.

But the neoliberals who think all government is bad and all regulation a burden continue their march towards……..well, the verges of madness.

And yet more evidence is provided of the economics of the playground dominating thinking in the Treasury, BIS and elsewhere.

What use are financial reports when they can be wrong by $5 billion, and yet be right?

Accounting, Auditing, Banking, Country-by-country Comments Off

Jan 142011

As the Financial Times reports this morning:

Goldman Sachs has revealed details of about $5bn in investment losses suffered during the crisis for the first time this week, in a move that will deepen the debate over companies’ financial disclosures.

The figures, issued as part of internal reforms aimed at silencing Goldman’s critics, show that the bank suffered $13.5bn in losses from “investing and lending” with its own funds in 2008.

But Goldman’s regulatory filings and its executives’ comments to investors at the time pointed to about $8.5bn of losses arising from its investments in debt and equity, as markets were rocked by the turmoil.

The diverging figures, which do not change Goldman’s overall results for 2008, are because of the fact that, like many rivals, the bank did not provide a full breakdown of profits and losses from activities carried out with its own resources.

There is, of course, a simple and obvious question that arises. If it is possible to publish the natural statements that are, apparently, true and fair, but which mislead investors on the true nature of losses to the tune of $5 billion, which can then be subsequently revised without necessitating restatement of the accounts, what use are those financial statements, and what does true and fair mean?

If, as the International Accounting Standards Board says financial statements are prepared to ensure that third parties can make appropriate decisions on the allocation of their resources to companies then material misstatement of data on losses generated is, surely, material to their understanding, a fact indicated by the fact that Goldman has now issued the data for exactly that reason.

The case for increased granularity, and the more robust approach to true and fair which has to be based on a third party and not an entity perspective becomes ever more pressing. Country-by-country reporting is, of course, part of the solution. it would not have addressed this particular issue, I admit, but with the increased focus upon segment reporting that it would require, necessitating increased disclosure in this area, the chance that losses on own account trading would have been better disclosed would have increased if this its emphasis had been present in financial reporting.

A majority of the horrors we have faced are the fault of the accounting profession

Accountancy, Accounting, Auditing, Big 4 Comments Off

Dec 222010

In this interview, Stanford’s Professor Joseph A. Grundfest talks to Charlie Munger, vice-chairman of Berkshire Hathaway. The interview apparently dates from about December 2008) but it remains bang on the button.

As Munger says right at the start:

I would argue that a majority of the horrors wee face would not have happened if the accounting profession were organised properly.

But as he argues, they aren’t.

Hat tip: Ian Fraser

E & Y accused of “massive accounting fraud”

Accounting, Auditing, Ernst & Young 3 Responses »

Dec 222010

As the FT reports:

New York prosecutors accused Ernst & Young of helping Lehman Brothers engage in a “massive accounting fraud” by approving a move that temporarily reduced the investment bank’s debt and gave investors an impression it was in a stronger financial condition.

The civil lawsuit, filed in a New York state court, alleges the auditing firm “substantially” helped Lehman mislead investors from 2001 until the brokerage firm’s 2008 bankruptcy filing by signing off on the accounting sleight of hand.

The strongly worded lawsuit goes further than accusing Ernst & Young of misconduct. It alleges Lehman engaged in a “massive accounting fraud” by using the accounting treatment, known as Repo 105.

The form v substance debate rolls on – and is, of course, reflected in much of the tax debate as well.

The form of these transactions was compliant, I presume to E & Y’s satisfaction, with regulation.

The suggestion is the substance was not. And I think we can have little doubt, considering the language used, that motive was the key factor here. Fraud can be defined as “an intentional deception made for personal gain or to damage another individual”. Note intent is key. I think so much resolves on this in so many situations. The prosecutors will, of course, have to show this intent. If they do the form will not matter much: the substance will prevail and in that case E & Y will be in trouble. If they can’t show intent then E & Y are in the clear in all likelihood.

But right now the message to the profession could not be clearer: substance matters. That has to be the message.

PS For more on this read Francine McKenna’s summary

The Big 4 – time for the resumption of the exercise of judgement

Accountancy, Auditing 8 Responses »

Dec 212010

The FT has noted:

New York state prosecutors could file civil fraud charges against Ernst & Young for allegedly helping Lehman Brothers hide debt, according to a person familiar with the matter.

The office of Andrew Cuomo, the New York attorney general who will be sworn in as the state’s governor next month, could file a lawsuit as early as this week, this person said.

If a lawsuit is filed, it would be the first allegations involving Lehman since the bank filed for bankruptcy in 2008, and the first charges against an accounting firm in connection with the financial crisis.

No doubt the issue relate to repo deals undertaken in the UK to get round US accounting requirements and it is important to note E & Y said they had no comment but had required with accounting regulations. To some degree I’m going to accept that they might have done – having carefully noted the difference between complying with the spirit and letter of the regulation in question – which seems a vexed question in gernal on this site at present – and will move on to the more systemic issue of concern which also comes from an FT article, shared in the public interest:

Fresh details have emerged of secret talks between bank auditors and the government during the financial crisis, as regulators prepare changes to the auditor’s role to lessen the risk of similar chaos.

Letters disclosed to the House of Lords economic affairs committee by KPMG shed light on why auditors did not in general express doubts about the viability of UK banks and building societies during the crisis.

They show how the Big Four audit firms – Deloitte, Ernst & Young, KPMG and PwC – wrote to Alistair Darling, then chancellor, in November 2008 for advice as to whether they could describe UK banks as going concerns. Their letter was written two months after the collapse of Lehman Brothers and tried to gauge the extent to which the government would continue to prop up financial institutions.

The audit firms wrote that the post-Lehman turmoil had left them “having to second guess government actions” when assessing whether a bank could access sufficient funding for at least a year – the minimum for it to be viewed as a going concern.

They argued that a bank could fail if the auditor’s report on its annual financial statements contained an “emphasis of matter” paragraph drawing attention to uncertainty about its going concern status.

Controversially, the auditors added that the government could help ward off such disclosures by reassuring them that it would continue to recapitalise failing banks. The letter led to a meeting between the Big Four’s UK bosses and Lord Myners, then City minister, in mid-December 2008.

Following these talks, Lord Myners wrote to the four firms to reassure them that “the government remains committed to taking whatever action is necessary to maintain financial stability, protect depositors and protect the taxpayer”.

This is more serious. First, so significant was the matter that it seems to me that it would still have required specific reference in the accounts.

Second, it is apparent that limited liability was breached at this juncture.

As Dennis Howlett has said on this:

It’s a very long time since I undertook audit work in any depth but unless things have changed there’s a few things going on here that require explanation.

Have the Big Four attempted to abdicate their responsibilities to the shareholders of the banks by seeking to obtain an understanding of likely government action? The answer appears to be a qualified yes. In my day it was standard practice to take up third party confirmation where it appeared that third party support was needed in order to keep a business afloat. The qualification went something like: ‚ÄòOn the basis of our examination of the assets and liabilities, XYZ may not be a going concern. We have received assurances from [named third parties] who have provided financial undertakings to maintain the capital base of XYZ.’ There are plenty of variations on this broad theme but that’s the essence. We would have been be remiss in our responsibilities to clients if we had NOT sought assurance and crafted some sort of similar wording. In my day, banks and other third parties (like large suppliers) relied on the audit report in order to understand how companies might stay afloat. I’m sure the irony of this situation is not lost on those auditors in similar situations today.

The FT describes the exchanges between the Big 4 as ’secret talks.’ Why? The Big 4 are said to have been afraid that qualification might lead to collapse. If that’s true then surely they already knew or had grave concerns about their ability to sign off a clean report and the viability of the banks they were auditing. It doesn’t matter which way you slice and dice this argument you come up with the same answer: ass covering.

Did the Big 4 discuss the issue in terms of a veiled threat? In other words did they turn to government and say something like: ‚ÄòWe think the banks are in trouble to the extent we need assurance from YOU that government will bail them out. If not then [name your bank here] could go out of business.’ That’s not stated though commentators seem appalled that the Big 4 might operate this way. As they should. But then given the UK government’s proclivity for spending tax payers money to shore up pretty much any bank, it doesn’t take a genius to work out what government’s response was likely to be.

I buy all that.

And Dennis’ further comment:

What the hell is going on with our profession? How many more desperate measures will we see the Big 4 take before either litigation or firm government action is taken to sort out what is rapidly becoming an anachronism that feather beds a few to the detriment of the many.

I am sure the defence will be “we played by the rules”.

As with tax avoidance, no doubt.

But what is becoming increasingly clear is that a society where playing by the rules is the aim is not sustainable. Auditors and tax accountants are meant to exercise their professional judgement. And candidly I don’t think they are. And that is dragging down the whole basis of the corporate edifice with risk to the entire market system, at cost to us all.

Those with a neoliberal bent who argue otherwise threaten us all. The time for a revival of the exercise of sound judgement is now.

Time to focus on the Big 4 – and their massive negligent in the banking crisis

Accountancy, Auditing, Big 4, Economics 2 Responses »

Nov 292010

The following is by Paul Cotteril and first appeared on Liberal Conspiracy and is reproduced here with permission:

The leftie blogosphere has been somewhat taken up recently with coverage and analysis of the student protests, and rightly so.

But in so doing this potentially huge story of rank corruption at the heart of the world’s banking industry risks being relegated to the obscure inside pages of the financial press, when it could do with being on the front pages of the papers that the occupying students hopefully get given by helpers from the outside.

It’s certainly educational, and may help with the formulation of demands‚Ä¶‚Ä¶

Auditors misled investors in the lead up to the crisis by supplying UK banks with a clean bill of health after being told taxpayers’ money would be used to bail them out, a House of Lords Committee has heard.

The Lords’ Economic Affairs Committee criticised auditors for signing off on banks’ accounts on the basis the UK Government would prop up the banks.

“Your duty is to report to investors the true state of the company. You were giving a statement that was deliberately timed to mislead the company and mislead markets and investors about the true state of those banks and that seems to be a very strange thing for an auditor to do,” said Lord Lipsey.