As the FT reports this morning:
The UK government ignored advice to put Carillion on its highest risk rating before its collapse in January, following pressure from board members of the now-bankrupt company that was a major supplier of outsourced public services.
If you wish for more information on the story, it's in plenty of newspapers. My belief is that we need to stand back from it and look at precisely what this story means. There are, I suggest, three dimensions to it.
The first is that inappropriate lobbying takes place, and it would appear that the civil service was susceptible to it. That is not my primary concern this morning.
Second, as is now obvious, the risk warnings about Carillion were raised far too late in government circles. It is appropriate to ask why.
Third, although not apparent from the above quotation, what the Public Accounts Committee report that underpins it makes clear is that there were just four potential ratings for a supplier of outsourced services to the government. These were green, amber, red and black: the last being the clearest indication that there was a previous three-tier system to which somebody thought a higher risk rating needed to be added.
Let me offer some thoughts on this, starting with the third issue first. What the simple indicator used demonstrates is that even supposedly sophisticated users of financial information are not able to analyse them in any complex fashion. I stress before the inevitable naysayers get in that the civil service will not be alone in this: we humans are simply not very good at handling complex data and resort to heuristics as a result.
What I also stress is that there is nothing wrong with this: better a heuristic than no indicator at all. The four-level risk indicator used might well have been appropriate if suitable data to make sure that the appropriate risk warnings were given had been available.
This then brings me back to the second point, that risk warnings were given too late. Part of this may, very clearly, have been the result of lobbying: indeed, I strongly suspect that is the case. But there is another dimension to this, and that is that the accounting data put out by Carillion was simply not fit for the purpose for which it was used.
In fairness to Carillion, this was not their fault. The information they produced was deemed appropriate by International Financial Reporting Standard and their auditors, whose sole real task is, these days, to ensure that they comply with those standards. But the reality is that the company, its internal accountants, the International Accounting Standards Board who produce International Financial Reporting Standard and the auditors all knew that the data that they produced was not intended to, and probably could not, meet the needs of the government in appraising the risk that it faced in contracting with Carillion. This is because IFRS accounts are quite specifically not designed to fulfil this task. I know this because the conceptual framework for IFRS says (in summary):
The primary users of general purpose financial reporting are present and potential investors, lenders and other creditors, who use that information to make decisions about buying, selling or holding equity or debt instruments, providing or settling loans or other forms of credit, or exercising rights to vote on, or otherwise influence, management's actions that affect the use of the entity's economic resources.
The paradox will be apparent: what the IFRS call ' general-purpose financial reports' are in fact decidedly specific information designed to suit the needs of a tiny proportion of the users of financial statements.
The IFRS conceptual framework then keeps digging holes for itself, saying:
The IFRS Framework notes that general purpose financial reports cannot provide all the information that users may need to make economic decisions. They will need to consider pertinent information from other sources as well.
This, of course, is a statement of pure contempt. The IASB knows that the company only publishes one set of accounts and that there will, therefore, be no alternative source of information on the financial affairs of the company for most users, but it does nonetheless tell them that they are on their own when finding it, knowing full well it will never be available.
Now, of course, it is true that a government who is a major contractor to a company could ask for additional financial information to support the contracts given. I do not dispute that. I rather hope it happened. But the fact is that the government was seeking to test the solvency of the company when moving Carillion to a high-risk status and the only useful information available for that purpose is the overall financial statements, which in this situation were not designed to fulfil that goal.
The International Accounting Standards Board claims that its International Financial Reporting Standard will result in general-purpose financial statements of use to the public. Rarely has a more misleading claim been made. IFRS accounts are not general-purpose financial statements; there are tools designed to assist high-frequency stock market speculation. And since most of the public does not participate in that activity for the vast majority of users of financial statements the information provided by IFRS accounts is knowingly not fit for purpose.
As a result nor is the International Accounting Standards Board.
And nor should accounts based on International Financial Reporting Standards be deemed acceptable in UK company law.
As long as they are we will get more Carillions.
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I think you are too generous in citing the complexity of understanding a business. Carillon became a cash ponzi scheme of the worst kind ( pushing sub-cintractors payment terms out to 90 days, and delaying payments using any possible pretext in performance terms, while getting 30 day payment from clients from a growing portfolio of contracts. Any basic cash analysis of the business would have made this clear. Our big four accountants are now either too stupid or too corrupt (and very possibly both). They have repeatedly failed to report danger signs to investors in an open and honest way. Accountants must be made more financially and legally liable for their failures if anything is to change.
“he primary users of general purpose financial reporting are present and potential investors, lenders and other creditors, who use that information to make decisions about buying, selling or holding equity or debt instruments, providing or settling loans or other forms of credit, or exercising rights to vote on, or otherwise influence, management’s actions that affect the use of the entity’s economic resources.”
So what? The primary users of company accounts are investors, as they are the only people likely to be interested in the accounts of a company on a day to day basis. Who else has a reason? Government? Once in a while maybe but you could hardly call government the primary user of company accounts.
“IFRS accounts are not general-purpose financial statements”
“the information provided by IFRS accounts is knowingly not fit for purpose.”
“As a result nor is the International Accounting Standards Board.”
“And nor should accounts based on International Financial Reporting Standards be deemed acceptable in UK company law.”
These are VERY big claims to make. I assume if you are making them you have an alternative? Which accounting standard should be deemed acceptable in UK law then?
This is so wrong
But as I will be addressing it in a blog tomorrow – in copying a speech I am making on the issue in Dublin tomorrow afternoon – might you like to read what I will post then?
I suggest investors are the least important stakeholders of a company for reporting purposes
I assume you are joking, right?
Investors are the most important stakeholders for a company. They own it. They are the people reporting is aimed at.
I’d love to know who is more important than investors in terms of reporting. I’m sure you are going to tell us.
Could you also tell us which accounting standards should be used instead of IFRS? If IFRS is is not fit for purpose then what standards are, or what would make them fit for purpose?
I don’t joke about such things.
Let’s get this clear. First, the idea that shareholders own the company is arguable: they don’t, all they own is a share in it, and that is something very different.
Second, it’s true that when acting together the shareholders can impose control upon the company, very often they have no such control at all.
Third, the relationship to emotion holds the company is decidedly transitory and is the easiest of all stakeholder relationships to break: it is gone in a moment. That is precisely why they are unimportant and should be the lowest interest group for those with stakeholder concern.
Who is more important: These are:
Customers
Suppliers
Employees
Pension funds
Government
Regulators
Tax authorities
Local communities
Civil society
And what accounting standards: wholly new ones, of course
The first problem is that IFRS are not intended for general use – they are designed for stock market investors in ordinary shares of the companies, unlike UK GAAP which was designed for the benefit of creditors. That IFRS are concerned with the accuracy of the balance sheet in a non-inflationary environment at the expense of the P&L account and that of the balance sheet in the real-life inflationary environment just makes things worse.
A second problem, only slightly connected in theory but significant in practice, is that while shareholders DO own the company, they do not normally control it.
Since it is apparent that the vast majority of movements in share value have nothing whatsoever to do with company performance, but reflect general market sentiment, to which accounting has almost no relationship, it is also clear that most shareholders do not use IFRS based financial statements to inform their investment decisions.
In that case preparing accounts for users who may come as no use of the information is irrelevant: what we now need are accounts that do serve a general public purpose. This will be my theme, tomorrow
With all due respect, the majority of market movements have nothing to do with the majority of shareholders, so that has nothing to do with the latter’s use of acounts.
My criticisms of IFRS are well-known and have, inter alia, led to some Britsh companies reporting in US$ to reduce the distortions created by IFRS. That, however, is not the point – in most cases I can drill down to operating subsidiaries that report according to GAAP, but the man-on-the-Clapham-omnibus doesn’t know how to do so – we need non-IFRS accounts suitable for suppliers and other creditors as well as IFRS accounts designed for shareholders.
We need non-IFRS accounts. Full stop.
It seems to me that major shareholders are rarely interested in “control” of the company (in terms of functionally directing it or managing it, even in strategic terms). Major shareholders in publicly traded companies will tend to invest because they back the management; if they are no longer prepared to back the management, their principle response is most likely to be to sell the shares and move on. This is how “markets” actually function. Whether this has anything whatsoever to do with sound, wise or efficient management is entirely contingent. Unless the holding is entirely the function of some form of market algorithm (which will also have little or nothing to do with “control” of the enterprise).
It is for that reason that I have always believed the efforts to correct major failures of business management through amendments to the role of non-executive directors (for example) are essentially trivial, of very limited effect, or frankly pointless exercises in PR.
Agreed
The markets work like herds, nit rational decision makers
Your answer makes me think you are joking, because it can’t really be serious, can it?
If shareholders don’t own a company, who does?
Minority shareholders don’t control a company. Why is that a surprise?
Not sure what you are trying to get at when you are talking about emotion being transitory, but shareholders are the most important relationship a company has. If they decide to dump their shares en masse because the company isn’t performing, then usually the company is going to be in serious trouble.
As to who is more important:
Customers and Suppliers: Their relationship with a company is private. They don’t have to buy from or supply to a company – they already have their say.
Employees: They don’t have to work for a company, but they also have legal rights and normally have some input into how it is run when they do. They don’t have any ownership rights, so why should they have control of how the company is ultimately run.
Pension Funds: You mean shareholders, then. Pension funds regularly make their views felt at AGMs.
Government, Regulators and Tax authorities: Already have their input into companies via law and regulation. Why should they have any more input? Are you saying you want government representatives controlling how companies run on a day to day basis?
Local communities and civil society: Apart from the difficulty of defining either in relation to many companies, they already have their input via the governments they elect and the rules those governments make. Again, why should they have anything to do with how a company is run past that point?
And the funniest bit:
“And what accounting standards: wholly new ones, of course”
Better ones. Obviously. No suggestions, or wholly thought ideas just a simple assertion that IFRS is inadequate and new ones will do the trick.
With respect, it is you who has no relationship with reality
I make clear: shareholders do not own companies. They own shares issued by companies. That is something very different indeed.
Your dismissal of the interests of stakeholders is just ridiculous not least because, although you may not be aware of it, UK company law actually makes their interests paramount. IFRS has subverted this, as I have documented
“Now, of course, it is true that a government who is a major contractor to a company could ask for additional financial information to support the contracts given.”
Would that not place the Government in the position of having “inside information”, not available to shareholders, investors or creditors?
Maybe
But it can ask