In this morning's video, I argue that the accounts of the largest companies in the UK and around the world are works of fiction because no company in existence has undertaken the transactions that they record. I ask, is that what we really need when we come to assess what the private sector is up to?
The audio version is here:
A ChatGPT-generated summary of the argument is:
The largest companies' accounts are fictional, misrepresenting reality.
Consolidated accounts mask internal trades and risks, hiding tax abuse and environmental impacts. This compromises creditors and public transparency, as subsidiary details remain concealed.
A better approach, like country-by-country reporting, could provide clearer insights into these companies' activities and risks globally.
The transcript is:
The accounts of the largest companies in the UK and around the world are works of fiction. I seriously mean that.
They are make believe. Made up. They are not representative of any truth that has actually happened. And that's a very serious allegation to lay against the accounting professions of the world, and all the companies that produce these accounts, But I'll stick by that opinion. I believe that some of these accounts should be entered for a literary prize because they are so abstracted from reality, just as fiction is.
Let me explain what I mean by all this.
If you pick up the accounts of a very large company, call it a public limited company in the UK - one of those quoted on the stock exchange - you will find a document which, if it is in printed format, will be hundreds of pages long. Some are 400-plus pages. But there is no company that ever undertook the transactions that are reported in those accounts. There is quite simply nothing like that company that issues that report anywhere in the world. Hence my allegation that these are a work of fiction.
The company that issues the report will be the parent company of the group with the name printed on the front cover. But that parent company very rarely trades with anyone. It owns a myriad of other companies that form the group that go to make up the organisation which is given the name of the parent company. It is those subsidiary companies owned and controlled by the parent company that actually trade.
So, if you go into a retail store owned by a quoted company, the store will be managed by some other company and not the parent entity.
That store will be supplied by a supply chain company owned by the parent entity, but different from the store itself.
There will also be an in-house insurance company.
There will also be an in-house bank, in all likelihood.
And there will be many companies to operate stores in many countries.
This group will expand incredibly rapidly if it does a bit of merger and acquisition activity, and very few quoted companies seem able to resist the idea of doing that as a way to achieve growth. Then they will acquire a few hundred other companies every time they acquire another group.
All of those companies will probably survive because nobody can remember why they were created. And therefore, rather like in a game of Jenga, they'll be too frightened to pull one of the blocks out of the whole edifice of companies that makes up the whole just in case, pulling that particular block out, for reasons that nobody understands, pushes the whole thing over. So, these things grow like Topsy.
Accountants get round this, by producing what are called consolidated accounts. It's a set of consolidated accounts that form that published document that I referred to at the start of this video. Consolidated accounts presume that all those companies that are under common control are one company.
But it is an assumption. It's not a fact. It's not a truth. It is literally a myth created by the accountants for their own convenience. There is no one such company. But they pretend there is, just as the novelist pretends that the world they write about exists.
And in this pretense to produce this set of consolidated accounts, all the trading between those companies under common control is removed from view. They literally eliminate it. But that's really, really important. Because, for example, almost all the tax abuse undertaken by almost all companies in the world takes place within those transactions between companies within the group because that's how they shift profits from high tax jurisdictions to low tax jurisdictions, for example.
And that's also how they shift manufacturing from jurisdictions with high environmental regulation to jurisdictions with low environmental regulation, for example.
So, we should know what is happening inside a group, but those accounts remove it from view.
Even more, they remove all the balances between those companies from the balance sheet. So we don't know whether a company within that group, within one particular country, might be at risk of failure because it is actually looking decidedly financially dodgy, even though the group as a whole is looking fine.
And the creditors of that one company in that one country might not even be able to find out for themselves. Looking at the parent company accounts will tell them nothing about what is going on in their particular domain with that particular company. So, the creditors of the company are put at risk by this approach.
And that's quite important because if you go back into the history of accounting, the main reason for the creation of accounts was to protect the creditors of the company from abuse by the directors of the company itself. And now we have the company itself putting out sets of accounts that don't even reflect the accounts of every subsidiary company, which accounts might also not be available on public record, anywhere in the world.
Now, all of this worries me because the use of limited liability is a privilege. Society lets companies have limited liability because there is obvious evidence that the accumulation of capital under common control can be a benefit. It can also, and let's be honest about this, be a threat. Monopoly is one of the consequences. But let's assume that the benefits overall outweigh the costs and therefore the provision of limited liability is worthwhile.
But those who might be prejudiced by the use of limited liability need to be protected. And if the set of accounts that they're given for the group as a whole does not explain how they are at risk then that set of accounts fails to meet the needs of those users.
Most of us are in some way or other amongst those users. We trade with these companies, whether we know it or not. We might place deposits with them, which are at risk. If we are ourselves in business, we might find it difficult to work out what risk we face by trading with this entity. And if we have a pension, and we invest in this company, we might not understand the full measure of the risk inside the company in which our pension funds place its funds because its accounts are, as I suggest, a bit of a work of fiction - a decidedly narrow choice of perspective on what is going on inside the world of that entity.
There are other choices available. For example, they could produce what are called country-by-country reporting accounts. It is a method of accounting which, I admit, I created, but it is now the law in 80 countries around the world because the OECD adopted it in 2015 for tax reporting purposes. Those accounts could be put on public record.
We could find out what multinational companies are doing in every country in which they operate as a result.
And we would learn a great deal more about intra-group trading between companies within the group as a consequence as well, because that system is designed to show that.
My point is, we have a system of accounting that is chosen to hide the true perspective of what is going on inside most of the world's largest companies from view. I don't believe that that is an acceptable risk now that they hold so much power in this world.
Accounting needs to rise to the challenge of meeting the needs of all the users of accounts in all the places that they are, whatever their need might be, and it isn't doing that. And as a result, it's failing us all, and it is not producing the public good in the form of a set of accounts that meet the need of users that it should be. And that's not good enough.
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I was in or near some betting shops this week which were almost all deserted, perhaps one staff, one customer, no-one on the machines. With minimum wage and taxes being so high, how can William Hill and Ladbrokes etc keep their retail estate going. Curious, I looked at the most recent Entain annual, and retail growth was 2% over the period, nominal as far as I could make out. Quite enlightening
William Hill is making big losses
Sounds like GERS. Only the Treasury is even smarter than British business, and moves from fiction to fantasy; because it doesn’t publish consolidated accounts either. It just publishes whatever it wants. It tells you only what it wants you to know. Crown prerogative.
Neither the OBR inside, nor the IFS outside even ask the tough questions. Like a totalitarian state operation, economists ask only the questions expected of them; challenging enough only to look basically plausible.
Much to agree with
Thank you and well said, Richard and John.
Further to John’s conclusion, let me add an anecdote from dad, a former RAF officer. He headed various medical units and was often involved with investigations. At the time of the John Stalker affair, he recalls his CO (and predecessor and nephew of a former PM* of the same name) saying that, when appointed to lead or form part of an investigation, one should know what the government wants.
*A PM whose name frequently arises when people examine the origins of the genocide in Palestine.
I did a finance module in my MBA.
All I saw was the abuse of language and obfuscation.
All I could think was ‘I’m on a course that is meant to teach me how to lead and manage an organisation and this stuff tells me nothing’.
I finished the module a huge sceptic about business accounting. And they don’t like you questioning anything either.
They most certainly do not….
It is all written on Tablets of Stone, don’t you know?
Matters are still very primitive in terms of accountability in human societies. Companies move their manufacturing to countries that treat the environment as a freebie – to countries that currency rig – give unfair tax breaks and government subsidies – all of which ignore the effects on the incomes of people in other countries.
Indeed there is a continuous battle going on between private companies that want to maximise money as a measure of their individual utility and acknowledgement that money is also a public utility hence the pressure on politicians to become shills and minimise the taxation on the private companies!
Isn’t this battle a never ending topic in the mainstream media (much of which of course is owned by private companies) with denigration of the use of money for public purpose, even denial of the commonsense way a monetary system has to operate?
Where is the tribalism these days? Much of it has transferred into private companies which try to downplay the fact for public consumption. Hello rust-belt cities and towns as the Americans call them which form the “swing states” their politicians continue to fight most vociferously over! The British meanwhile who’ve suffered the same engage in displacement activities, mainly siesta but then occasional outbursts like Brexit and riots!
https://en.wikipedia.org/wiki/Rust_Belt
Oh I though this was going to be a complaint about accounting standards and the sorts of unrealistic assumptions that go into which numbers are shown or not shown (and the atrocious nature of the summary financial information filed by many small UK companies these days)
Are you really against consolidation by large companies? How else do you show the financial position of the group as a whole?
The consolidated accounts will also include the stand-alone accounts for the parent company as a single entity, but they will be relatively uninformative if (as it is usual) it is purely a holding company for subsidises.
Many jurisdictions require each subsidiary to file its own accounts to be available to the public. The UK certainly does.
My complaint is that consolidatuion is one very limited world view focussed solely on shareholder need and even then failing to deliver for the reasons I note
My argument is we need so much more
Is that wrong?
And in many jurisdictions accounts are very hard to find
Companies House is rubbish but it ios better than many EU countries where local chambers of commercce have them and you have to find which one, for example. That is nightmarish
Richard makes a very perceptive point. I see it may look like a criticism of consolidation; but in fact the argument, it seems to me is that the virtue of consolidation is done not to reveal but conceal (beyond the minimum required to show consolidation); the object may very easily be to hide a multitude of deflections from what is really happening across the consolidated businesses. It seems to me that this demonstrates that published accounts are devised to move the public eye from the substance, to the form; the whole process is an elaborate exercise in tax avoidance; executed to ensure nobody can see adequately what is really going on.
Where I may differ from Richard (who has much greater expertise than I, of accounting theory and practice), is that I have never felt that States can or should rely on accounting principles or practice to deliver the taxes that States expect. All accounts are abstractions; meat and drink for the end of tax avoidance. The techniques of avoidance will always end, one step ahead of tax legislation. The best paid and sharpest minds in law and accounting are paid by business, not Government. HMRC is “behind the eight-ball”; and the final coup de grâce is delivered by government. It makes sure HMRC is not equipped and resourced to do its job, except perhaps to pursue benefits cheats (and it probably spends more on pursuing benefit cheats than the tax ever recovers, or is worth the effort – except for cyncial political purpose).
We live in a wirld of realpolitik.
We do….
[…] have done a couple of summaries this morning in the two blogs I have published so far today, here and here. The first was almost wholly ChatGPT generated in 50 words. The second required 70 words […]
Related, the Financial Conduct Authority (FDA) reports:
PwC fined £15 million for failing to alert the FCA to suspected fraudulent activity at London Capital & Finance plc (Published today 16 Aug 2024)
The FCA has fined PricewaterhouseCoopers LLP (PwC) for failing to report to the regulator their belief that London Capital & Finance plc (LCF) might be involved in fraudulent activity. This is the first time the FCA has fined an audit firm.
In full: https://www.fca.org.uk/news/press-releases/pwc-fined-failing-alert-fca-suspected-fraudulent-activity-london-capital-finance-plc
Reuters news item: https://www.reuters.com/business/finance/pricewaterhousecoopers-fined-19-mln-by-uk-watchdog-2024-08-16/
Thanks
I was going to cover this, but doubt it now
Another failure, and a minority inconvenient fine
There is separately the potential problem of accounting for intercompany loans in subsidiary or connected accounts. These balances can be carried on the balance sheet and may sometimes risk distortion of solvency if continuously carried without being written down when owed by an insolvent connected company. This issue is explained here “Risk Of Intercompany Loans In A Group Of Companies” https://www.oliverelliot.co.uk/2022/05/21/risk-of-intercompany-loans-in-a-group/
“The issue of intercompany transactions was touched upon recently in the case of Queensgate Place Ltd v Solid Star Ltd & Ors (Re Solid Star Ltd, Companies Act 2006 and Insolvency Act 1986) [2023] EWHC 2277 (Ch) (“Queensgate“) in which the Court noted:
… he has clearly treated the funds of a number of companies which he controls or in which he has an interest as a single pot, from which payments can be made at will without any regard as to whether the payment being made is properly a liability of the company whose money is being used to pay it and without any adequate records being kept of such transactions.”
Agreed