IFRS failed UK banking because accounts “were unreliable for capitalism as they did not show the capital”

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I’ve just posted on Tim Bush’s claim that the application of International Financial Reporting Standards in the UK left the accounts of UK banks so fatally flawed that the failure to report properly was a major contributory factor to the crash of the UK banking sector.

 

Tim has now authorised me to publish the paper he has written that makes this claim. It is here. It was written in response to a consultation on the future of UK accounting standards – which has implicit in it the suggestion that they be replaced by International Financial Reporting Standards.

As Tim puts it, this proposal is fundamentally flawed because:

¬? This proposal omits the fundamental objective of creditor protection and capital maintenance (part of “stewardship”) contrary to the law. The IFRS for SMEs and the full IFRS does not include it. This ASB proposal does not address this deficiency, but instead propagates it far more widely.

¬? Because the ASB appears not to have fully understood (since before 2004) the law relating to creditor protection1 embedded in the Companies Act itself, (applying to both companies using IFRS and companies using “UK GAAP” ), the ASB has already approved standards that appear to contravene the law in respect of creditor protection. The ASB has no dispensation to break the law. The ASB’s role is to set its quasi-legislative standards under the law.

¬? The law is such that shareholders can rely on the profits in the audited accounts -including those of banks - to approve final dividends declared, unless the directors or auditors have indicated to the contrary in the accounts. Overstating profits could lead to an illegal distribution (which is a criminal offence), as well as a breach of Section 386 (also a criminal offence). Some aspects of IFRS do overstate profits and indeed several UK and Irish banks collapsed after paying dividends. They did not have the capital that they presented, and they were not going concerns. The true situation was that business models were loss making and actually consuming capital. The accounts were unreliable for capitalism to function properly as they did not show the capital.

It’s a remarkable claim, and yet one that when laid out as Tim does seems all too obviously true.

My own recent engagement with the International Accounting Standards Board on country-by-country reporting has resulted in suggestion that a review is needed on the purpose of accounting – a call I have heard from KPMG amongst others. The relevance of that suggestion is only increased by this new revelation.

We need accounts that are reliable, fit for purpose, of use to society and that uphold the right of all creditors (including those in civil society and all taxpayers) in a world where limited liability is permitted. It is very obvious that the International Accounting Standards Board is not delivering such standards, and the cost to the world is now apparent.

This is reform that cannot wait. Not if we want to avoid the next round of bank collapses. And they're ion the horizon already.