Auditors: Market concentration and their role - Economic Affairs Committee Contents

Further supplementary memorandum by Mr Timothy Bush (ADT 19)

Technical addendum from Timothy Bush, to support evidence of 26 October 2010, given the evidence given 9 November by the FSA and FRC which is contradictory in two places.

  1.  Mr Haddrill stated that, prior to IFRS (2005), there was no UK standard on derivatives. That is incorrect. There is a UK standard, FRS 13 (1998) which is actually entitled "Derivatives and other financial instruments".

  Also, UK standard FRS 5 (1994) deals with securitisations (as well as off balance sheet transactions), see the attached notes on both standards on the ASB website.

  Further, and superior to that, are the Accounting Preparation Rules of the Companies Act itself. Part 2, Section A, 17-21 are the overarching accounting principles that must be adhered to.

    Para 19 (a) requires prudence (and no unrealised profits).

    Para 77 (3) is a catch-all contingent liability clause. 

  All of this was then pulled together by the bank specific standard (SORP) from the British and Irish Bankers Association (attached)[23] dated 1997 (and regularly revised). Page 51 et seq is the derivative section.

  Mr Hadrill refers to prudence still being in the regulatory system, which seems to accept that it is no longer in the accounting system.

  That does not work if, the company is not regulated (eg Cattles, which lent, but did not take deposits), nor does it work if the regulator is not alert, or themselves misled. The statutory purpose of Companies Act accounts is a stewardship function, irrespective of whether the company is regulated or not.

  2.  Further, on bad debt provisions, Mr Thorpe of the FSA stated correctly, that IFRS [by 2013 at the earliest] will move to an "expected loss" basis (forward looking) of bad debt provisioning.

  However, he stated that the "incurred loss" model of IFRS was the same as had been in the UK for 30 years. That is in my opinion not correct.

  IFRS has excised the general presumption of prudence (above) as a valuation method, and replaced the British and Irish Bankers' Association SORP. Para 9 of page 5 of the BBA SORP deals with both specific and general bad debt provisions. It set an aspirational goal for the carrying value of loans set out as:

    "Although specific and general provisions are computed separately, they are in effect components of the same provision. In total the specific and general components of a bank's provisions for bad and doubtful advances should represent the aggregate amount by which the bank considers it necessary to write down its impaired advances in order to state them at their expected ultimate net realisable value. "—(UK GAAP)

  IFRS (IAS 39) requires provisioning on the basis of evidence of default (ie the customer is already not paying), rather than forward looking. It is highly qualified compared to UK GAAP. A PWC paper "joining the dots" which summarises this as: "IAS 39 specifically states that losses that are expected as a result of future events, `no matter how likely', are not recognised. "

  The FSA's own discussion paper on the implementation of IFRS (04/17, October 2004) "Implications of a change of Accounting Framework". para 2.42, says:

    "General provisions under UK GAAP are provisions for losses that have been incurred but not yet individually identified. There is no equivalent concept under IAS 39, but the standard does permit companies to assess impairment "individually for financial assets that are individually significant, and individually or collectively for financial assets that are not individually significant"—(IAS 39.64 as at 31 March 2004)."

  Although superficially, the FSA seems to have used similar language to UK GAAP, the word "incurred", the FSA paper itself reveals that the definition that sits beneath is, both qualified and very different. The use of the term "permit" a provision, is clearly restrictive. The UK GAAP position is aspirational, requiring general provisions and for the total amount to be the expected realisable value.

  From reviewing the accounts UK and Irish ordinary lending banks which collapsed, it can be seen that general provisions disclosed in the accounts either fall under IFRS, or disappear altogether.

  The benefit of the audited statutory accounts of a company is for the body of members, to protect the capital, from hidden losses for the benefit of the members and hence the creditors. In my opinion, the accounting standard (IAS 39) does not meet that function in concept, or practice. Further to that, the FSA as a regulator seems to have assented to that deficiency.

  The implication of this is that the regulatory interest in statutory audits—regulation has traditionally free-ridden off the contractually audited accounts for the benefit of the members—has intruded to the extent of being a part of a train of events that has then undermined the interest of the members, and then of the creditors.

11 November 2010

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