Examination of Witnesses (Questions 447-465)
Professor David Myddelton, Mr Steve Cooper and Mr
Roger Marshall
18 JANUARY 2011
Q447The Chairman: Good morning, gentlemen. Thank
you very much for coming. We have quite a lot to go through this
afternoon. We have three sets of witnesses, so we will try to
keep the questions as short as possible and fairly concise with
the answers, if that is possible. If you are asked a question
and the person who goes first covers it and the other two are
happy with it, please do not feel obliged to follow in. We just
assume you are content with the answer. I would be grateful if
you would identify yourselves when first speaking and speak loudly
and clearly for the benefit of the webcast and the shorthand writer.
Would you like to make an opening statement or will we go straight
to questions?
Professor Myddelton: I wouldn't mind making
a brief opening statement, which is that I think there should
not be any accounting standards at all.
Q448 The Chairman: That is very brief.
Thank you very much. We will come to it no doubt in the questions.
Can I start off by asking this question, because you will know
we had quite a lot of focus on the accounts in the banks? Supposing
the management of a UK bank in 1990 presented a set of accounts
that contained leverage similar to that in 2010 or even 2009,
would the auditor have qualified the audit report? If so, what
has changed? What is now missing from the auditors' appraisals
and judgments?
Mr Marshall: Shall I take a stab at that, as
an ex-auditor? I do not think the auditor would have qualified
the audit report purely because of leverage then or now, providing
the leverage was properly disclosed in the financial statements,
but clearly the leverage would put them on notice to make more
inquiries about the sources of financing and the durability of
financing. I don't think then there would have been quite so much
leverage. The securitisation market hadn't opened at that point;
there wasn't the same amount of interbank lending. But as I say,
I don't think that leverage on its own would have led to a qualification
then or now.
Mr Cooper: This is not perhaps so much a question
for the IASB as a standard setter. The question of whether an
audit report is qualified is an issue for the auditors. As Roger
said, so long as the leverage, the appropriate disclosures, are
provided in the financial statements, then that will be it in
terms of compliance with the accounting standards, so probably
not so much of a question from an accounting standards perspective.
Q449 Lord Tugendhat: Mark-to-market
and mark-to-model have also featured quite a lot in our inquiry,
and there have been those who have argued that perhaps inappropriate
IFRS innovations have led to correspondingly inappropriate volatility
in financial results from one period to another. How, may I ask,
do you feel about this?
Mr Cooper: Perhaps I will take that one first.
Mark-to-market accounting has been around for a long, long while.
Even before the IFRS was used in the UK, we have had the use of
fair value for trading assets for many years. I think most people
believe it to be entirely appropriate that we should have fair
value in some circumstances. The IFRS is a mixed measurement model.
We have some things at amortised cost, and some things add a fair
value. In fact, for many banks, the majority of their assets are
measured at cost with impairments not at fair value. Certainly
the crisis has presented many challenges, and there have been
challenges for us as well. We have certainly reviewed very carefully
the standards that we have. We look very carefully at where fair
value should be used, and where it shouldn't be used. We have,
in fact, revised the rules for bodies at fair value fairly recently.
We've issued what is called IFRS 9 to replace the previous rules.
It hasn't changed it dramatically. Many of the things that were
at fair value still are. I think it is perfectly appropriate that
they should be. A failure to recognise changes in value won't
provide a true and fair view in company financial statements in
many cases. We have changed the position slightly. Some things
that were at fair value are now at cost and vice versa. We have
rationalised it and made it more principles-based. The ability
to do that has come about partly because of the crisis. It gave
us an opportunity to look really hard at these things. IFRS 9
has been in place for some time. It hasn't yet been endorsed at
the European level. We have other aspects of IFRS 9 yet to complete.
We'll probably talk about impairment of loans later on, but certainly
we have looked at the whole issue of fair value to try to get
a more principles-based approach to the use of fair value in financial
reporting.
Q450 Lord Smith of Clifton: Gentlemen,
are we correct in believing that there used to be a true and fair
override, which took precedence over whether or not the financial
statements were consistent with the accounting standards, but
that now the reverse is the case?
Professor Myddelton: I believe the Companies
Act still requires company accounts to give a true and fair view.
It's true there was a judge, Mary Arden, nearly 20 years ago,
who said that, in her opinion, giving a true and fair view would
mean only complying with accounting standards, but that has not
been tested in the courts as far as I know. It is a legal question,
so there still is, as far as I understand it, a requirement for
a true and fair view. In my opinion, that is the only bit of regulation
of accounting there should be—a requirement in the Companies
Act for company accounts to give a true and fair view, full stop.
Mr Marshall: May I say something? The FRC did
actually get a Counsel's opinion from Mr Moore after the IFRS
came in to confirm that the true and fair view is the overriding
feature of companies' accounts. I think companies have to pay
attention to a true and fair view, which actually takes precedence
over the accounting standards. Now, there have been quite rare
cases under the IFRS of companies using the true and fair override
to depart from the accounting standard, but they are not unique.
Indeed HSBC, in 2009, used a true and fair override to depart
from one of the IFRS accounting standards. So I think that the
true and fair view concept is still very much in the centre of
UK accounting.
Professor Myddelton: Chairman, can I say one
other thing? Of course, there can be more than one true and fair
view. For example, most companies use straight line depreciation,
but if another company wanted to use declining balance, that would
be perfectly appropriate, though different. So there isn't a single
true and fair view.
Mr Cooper: I think there is a perception that
has come from somewhere that IFRSs do not have a true and fair
basis, which I think is completely untrue. Paragraph 15 of IAS
1 says that financial statements shall "fairly present the
financial position, financial performance" et cetera. We
don't use the words "true and fair view". Those originated
in this country. We write international standards that are used
right across the world. One of the key issues that we have is
translation and making sure that things translate well into other
languages, and "fairly present" is the phrase that we
have used, but I think everybody identifies that to mean "true
and fair view". The true and fair override is in IFRS. It
is in IAS 1. It is on the same page. Paragraph 19 says that, in
certain circumstances, it may be appropriate to depart from a
specific set of rules if you need to do so in order to fairly
present the information, fairly present the underlying economics
of the business and the transactions entered into. So I do not
believe there is any significant difference between the wording
in international standards and what we have in UK accounting and
UK legislation.
Mr Marshall: If I may just add one other thing
briefly, the opinion I quoted from Counsel says, "The requirement
in IFRS to present fairly is not a different requirement to that
of showing a true and fair view, but is a different articulation
of the same concept", so I think we understand what the IFRS
says as identical to a true and fair view.
Q451 Lord Forsyth of Drumlean: I
wonder if you have had an opportunity to read some of the evidence
that has been presented to the Committee, which might be summarised
as the IFRS encouraging a kind of box-ticking approach as opposed
to a judgment approach. Now, you have not really addressed that
in your answer to the question.
Mr Marshall: I am happy to. Shall I start on
that? I think the IFRS is a more complete set of accounting standards,
so it probably ties the company, the preparer and the auditor
down a bit more on how best to express the results of the company
in the accounts. But the IFRS also has more requirements on the
company and the auditors to make judgments, for example on fair
values and on estimates, so I do not think the IFRS on its own
creates more of a box-ticking approach. In fact, the opposite
may be the case.
Q452 Lord Shipley: It has been put
to us that accounting standards contributed to the global financial
crisis by disallowing companies from providing prudently for expected
future losses, which weren't then apparent in the current performance
of an asset. So, for example, a sub-prime mortgage book that had
not started to be significantly impaired would have been overvalued,
profits overstated and perhaps bonuses and distributions excessive.
Have you a view on this?
Professor Myddelton: Yes. I think prudence is
a very valuable concept in accounting, based on hundreds of years
of commercial experience, but standard setters don't like it.
They can speak for themselves, but it is asymmetrical. It basically
says that, if anything, understate the position; don't report
profits before you are absolutely sure they have arrived. Most
commercial people think prudence is important, but as I say, standard
setters don't like it and have really tried to outlaw it.
Mr Cooper: Perhaps I can deal with the prudence
issue and then I will come on to the expected losses. Prudence
does permeate accounting standards, revenue recognition, and all
sorts of areas. We are careful to make sure that profits are only
recognised when they really are profits. However, prudence acts
two ways: if you understate things now, it gives an opportunity
for companies to report a profit later; and at the very times
that things are getting worse, if you are living off past fat
and past unrealised profits, you can conceal the bad things that
are coming later. So we do not want to create a bias within financial
reporting that has that counterintuitive effect later on. We want
things to be realistic, neutral, to faithfully reflect the economics
of transactions. Going on to the incurred losses, the expected
losses, the current model that we have and the UK had before is
an incurred loss model, and the idea is to wait for a triggering
event before you can recognise a loss on a loan. Now, you could
argue that that means that you have to wait. Now, to a certain
extent, you can look forward. You have concepts of collective
provisioning, of IBNR—incurred but not reported—and
people do look forward to a certain extent within the existing
model. But it is very true that if you expect loans to go bad
three years from now, the customer is currently paying and there
is no indication that they are going to stop paying, but you just
think that some extra of your loans will go bad in three years
and that it wouldn't be possible to provide now. As a result of
that, we have been looking now for more than a year at the incurred
loss model with a view to modifying it and looking much more at
expected losses. We issued an exposure draft, a draft accounting
standard on this last year. We spent six months consulting on
that, particularly with the banks, to make sure that a more forward-looking
expected cash flow model, as we described it, would be operational.
There were certainly many operational challenges in applying that
to open portfolios. We have been redeliberating that since. More
recently, we have been redeliberating it with the FASB, the US
standard setter, to try to reach a converged solution on that.
So those discussions are ongoing and it's very true that we do
believe that we can improve on the incurred loss model. However,
it's a matter of timing about exactly when the losses are recognised,
and within the existing model there is flexibility to look forward
to a certain extent.
Q453 The Chairman: If what you are
looking to propose were in operation in 2007 and 2008, would that
have made a difference?
Mr Cooper: We were talking about this earlier.
I am not sure it would have—it's difficult to tell, of course,
because you can try to put yourself in the mind of somebody at
that time and what losses were expected. When the crisis first
hit people weren't necessarily talking in terms of the severe
downturn or the consequential effects on the mortgages and the
reduction in house prices. So losses might have been reported
earlier, but one would have to look very closely at the exact
timeline of the events at the time to see whether perhaps things
would have come in one, two or three quarters, whatever it was,
earlier as a result of an expected loss model.
Q454 The Chairman: What is the expected
timetable and programme on the discussions you are having at the
moment?
Mr Cooper: We are going to issue a supplementary
document quite shortly that looks at trying to modify what we
had originally to make it more operational. We feel that we need
to put that out for public consultation so that we can have some
proper feedback on the operational issues and about the model
itself. That document will be issued jointly with the American
FASB and we are going to propose a model that is common between
the two. We do have a way to go, though, to finally resolve this.
Our target is to issue a final standard this year. I mentioned
IFRS 9, which is the standard that we issued dealing with the
fair value measurement and what is a fair value. It will be a
supplement to that. But the target is to issue that this year.
However, implementation will be some years out. We haven't decided
exactly what the implementation date will be, but it will be at
least two or three years, because moving from an incurred loss
model to an expected loss model would have significant systems
implications for the banks and it would just not be physically
possible to implement it sooner than that.
Professor Myddelton: May I just make the point
that there isn't a single correct answer, so that two banks for
example might take a different view on whether they should be
providing for losses or not? It's very hard to write a standard
that covers that satisfactorily.
Q455 Lord Hollick: I think that brings
us to the question of judgment. One of the key judgments, of course,
is around going concern. A number of witnesses have said how important
that is to their usage of company accounts, and yet going concern
judgments that were made around banks at the end of 2007 and 2008
have proved, in retrospect—in pretty short order in some
cases—to be completely wrong. How valid and helpful do you
think it is and what can be done to improve matters?
Mr Marshall: I think the going concern clearly
is a forecast and so it cannot be treated as completely as reliable
as, say, the historical financial information, which is backward-looking.
I think that first management have to form a view as to whether
the accounts are prepared on a going concern basis and they have
to back that up. Perhaps a paper goes to the board explaining
why there is no reasonable doubt about the validity of the going
concern basis. I think the auditors then have to challenge the
assumptions there. They have to go and talk to the various people
involved and make sure that, in their view, there is reasonable
evidence that finance will be available to the company or to the
bank at least for the next 12 months or the foreseeable future.
Whether or not those judgments were correct at the time, I can't
tell, because I wasn't involved, but it is for the auditors to
test those judgments.
Professor Myddelton: The future is uncertain,
so you cannot expect auditors or anyone else to guarantee to make
correct forecasts. It is rather like providing for a bad debt.
You may say, "I don't think it will turn out bad", and
then be wrong. There may not be a systemic problem with that;
it's just the nature of the uncertain future.
Mr Cooper: I think from the IASB's perspective,
we would regard that as an audit issue, not something that really
relates to accounting standards.
Q456 Lord Moonie: Staying with going
concerns, we understand that auditors would deem a company to
be a going concern even if its continuance is dependent upon an
expected major capital restructuring, even a nationalisation,
under which existing shareholders may lose almost everything.
Is that so, and do you consider it to be satisfactory? Does this
relate to accounting standards or auditing standards or both?
Mr Marshall: It relates to both. Accounting
standards require the accounts to be prepared on a going concern
basis unless that's manifestly not the case. I think the reason
is that accounts on a going concern basis are much more useful
than on a break-up basis. On a break-up basis, many of the assets
would be written off; there would be provisions for lots of closure
costs, and so on. I am thinking perhaps more about a manufacturing
company than a bank, but there would be similar sorts of issues.
So the convention is, and I think the Companies Act requires,
that accounts are prepared on a going concern basis. Now, if there
is no material uncertainty about the going concern basis, the
directors would prepare the accounts on that basis; the auditors
would accept them. If there are material doubts, then the rule
is that those uncertainties have to be explained in the accounts
and the auditor then refers to them in the audit opinion. Clearly,
if the auditor is not happy with the explanation or, indeed, the
preparation of the accounts on a going concern basis, then the
auditor has to qualify his opinion. So I think it is more to make
sure there is proper disclosure in the accounts of those uncertainties
and probably the way in which the directors are proposing to resolve
those uncertainties, perhaps a capital reconstruction.
Q457 Lord Forsyth of Drumlean: Could
you tell us what the position is with the IFRS being adopted in
the United States?
Mr Cooper: I'll take this one. We are eight
years into a nine-year programme of converging the IFRS and the
US GAAP. We meet the FASB on a very regular basis and are making
very good progress. We have converged in a number of areas: share-based
payments and business combinations. We are working on issuing
some new standards on fair value measurement and other areas shortly.
We have a number of challenging projects on the go at the moment
with respect to revenue recognition, leasing, financial instruments,
which we were talking about, but the objective is to achieve greater
convergence there. Convergence, however, is only part of this.
The key question is adoption of the IFRS in the United States.
That is an issue, of course, for the US and not for the IASB directly,
although of course we work closely with the US and the SEC and
talk to them on a regular basis. My understanding is that the
US SEC will make a decision later this year. That decision may
not be the simple adoption of the IFRS in the US. It may involve
allowing certain US companies to use the IFRS and maybe set some
date in the future for making it mandatory either for a certain
group or for all listed companies. There are a number of options
that the US SEC might choose to take in this regard. From our
perspective, we are making a lot of progress in converging and
achieving the ultimate goal, which is a single set of global high-quality
accounting standards to enable investors to make better investment
decisions, to be able to compare across borders, to support an
international capital market. That's the whole objective of the
exercise.
Q458 Lord Forsyth of Drumlean: If
you had to bet your shirt on it, when would you say it would be
adopted by the US?
Mr Cooper: I am reluctant to speculate. A decision
will be made, I think, at the end of this year. I think it is
perfectly possible that we might see, in the fairly short term,
the permission for certain US companies to adopt IFRS. We may
well see a date set for when the US will adopt IFRS for all companies.
I do not know. I am not in a position to give a view on it. It
could go different ways. There is strong lobbying in the US pro-IFRS
adoption. Many, particularly the larger companies, see enormous
benefits in having a single accounting system for all of their
subsidiaries throughout the world. At the moment, obviously, using
different accounting systems and different places and training
people on different systems is an enormous cost for them, so some
of the large companies in particular are very pro adopting IFRS.
Some of the smaller and medium-sized US companies do not see the
benefit. They have US GAAP. They have all their systems set up.
They are not raising capital in the international capital markets,
so for many other companies there is far less of a benefit. There
is clearly a lot of lobbying going on in the US to influence that
decision. I am not in a position to say which way that is going
to go.
Professor Myddelton: Chairman, could I make
two points really? One is that there are important philosophical
differences between particularly the American and the British
traditional sets of accounting. It is not just a technical thing
that can be sorted out, and it has taken many years. I can quite
understand Mr Cooper being unwilling to speculate on when it will
happen.The second point I want to make is that I think it's extremely
undesirable. International harmonisation is a smooth sort of phrase,
but I think a global monopoly on accounting is very undesirable.
I like the idea of competition and continual evolution. Some of
the changes in fair value accounting that were referred to earlier
came about, in my opinion, only because the Americans had already,
and ahead of IFRS, come to a more satisfactory conclusion. If
we hadn't had that competition, if we had already had a global
monopoly, IFRS may never have changed.
Q459 Lord Forsyth of Drumlean: So
do you think it is never going to happen?
Professor Myddelton: I think it is inevitable
that it won't happen, because the differences, political and philosophical,
are too big, and I'm pleased if that's the case.
Mr Cooper: Many, many countries throughout the
world have decided to adopt IFRS or are in the process of going
through that, so Korea is applying IFRS for the first time this
coming year, as are Brazil, Argentina, Mexico. Japan has a convergence
process. They are now permitting IFRS to be used in Japan and
I understand quite a number of countries will be using it next
year. They will be taking a decision, I think, in 2012 or after,
about mandating. Canada is using IFRS for the first time this
year. Of course, the whole of the European Union is using IFRS.
The cultural business differences amongst all of those countries
are quite diverse, and yet people recognise the benefit of having
a single set of high-quality standards, having comparability,
facilitating cross-border investment. Many of the differences
that Professor Myddelton talks about have been overcome in the
interests of having this comparability. Sure, there are challenges
with the US. The US legal system in particular presents enormous
challenges when reporting litigation liabilities, for example,
and there is the whole issue of disclosure, so there are certainly
massive challenges that we have in trying to harmonise with the
US. I wouldn't minimise those, but there are also challenges in
many other countries and we have successfully dealt with those.
Even China has essentially adopted IFRS. It's not full adoption.
There are one or two things that they are not so confident about.
They don't have a sort of evaluation community that is well-developed,
so there are certain things that they scope out of IFRS. We hope
that they will fully adopt in the future, but in most respects,
most Chinese companies that report on Chinese accounting and separately
on IFRS—the ones which are listed in Hong King—do
not have a difference at all. So even China has effectively adopted
IFRS, in spite of the obvious differences in the political, legal
systems and business approach in that country.
Q460 The Chairman: Professor Myddelton,
given the increasingly international and global reach of companies
and economies in a world in which you didn't have IFRS but you
had a whole load of different accounting systems, how would you
deal with that?
Professor Myddelton: I'm not against voluntary
guidelines. Don't forget that we are talking in the context of
compulsory instructions. When I was a young accountant, we had
what were called recommendations: voluntary guidelines. I have
brought them with me and here they are; the whole lot. We didn't
have 2,000 pages of regulations as we have now. We had 150 pages.
I think it worked perfectly well, because it enabled, indeed it
required, accountants and auditors to use their professional judgment.
It was up to them—ultimately the courts, not the standard
setters—to decide what a true and fair view consisted of.
I think that could work perfectly well. Let's not kid ourselves;
producing accounts, whether internationally or not, is an extremely
complex business. First of all, annual accounts are only interim
accounts in the ongoing life of a business, and, for all sorts
of reasons, they cannot be completely accurate. My latest book,
which I'm not trying to sell, is called Margins of Error in
Accounting. It hasn't in fact sold very well, and I think
I can understand why, but the point is that there will always
be margins of error. So there isn't a perfect solution just waiting
if only the IFRS and the US authorities can get together. There
never will be a perfect solution, so I am quite happy to allow
evolution and trial and error—experimentation—to see
what other people are doing. I think that's the best way to progress.
Your question implies, "Oh my goodness, I'm suggesting a
system that won't be perfect". Yes, I am, and that's inevitable.
I may have misread it, but that's inevitable. There's no way around
that. I can live with that.
Q461 Lord Moonie: Is the corollary
of that that if we rely too much on a single set of standards
we are more likely to get systemic errors in the system?
Professor Myddelton: Absolutely. It's a very
high-risk strategy, as we saw in the financial crisis.
Mr Cooper: I think, though, that the greater
risk is not having these standards. A good example is share-based
payments, when companies pay their employees by giving them free
shares or stock options. Prior to the issuance of a standard seven
or eight years ago, whenever it was, these things were not reported
as expenses, either in UK company accounts or pretty much anywhere,
and it wasn't until the standard was issued that what was clearly
a transfer of value to employees was actually reported as an expense
in the profit and loss account. A failure to issue standards just
doesn't lead to people going towards the best accounting. I think
people stick with the worst accounting in the vast majority of
cases. That was a very good example of a positive effect from
issuing an accounting standard. Financial statements became far
more relevant, transparent and useful as a result of that standard
being issued.
Mr Marshall: As I say, I am not necessarily
arguing for one set of accounting standards worldwide, but over
the Christmas holidays I read two of Professor Myddelton's books.
In the previous book to the one he is selling at the moment, I
think he gave six advantages of accounting standards. He gave
them rather faint praise, and I'll leave it to him to argue against
them.But, clearly, to produce any sort of reasonable accounts
without accounting standards you need either a well-meaning company
or a robust auditor, and if you don't have at least one of those
it may lead to problems without standards. The standards, at least,
provide a spur to those to get it right. You also need to protect
investors by giving them certain minimum disclosures, which, without
accounting standards, you're not going to get. You want some sort
of consistency, so if you are looking at two companies in the
building industry, and one shows that profits are going up and
one down, is that really what is happening or is it just that
they're using different standards and they're actually doing about
the same? There are a number of advantages for accounting standards
that I won't fully go into now. I'll leave Professor Myddelton
to provide the counterargument.
Professor Myddelton: It would take too long,
Chairman, to go through all the disadvantages. I wanted to make
two points. One, as Hayek points out, is that you can have generally
accepted rules without any standard-setting body imposing them.
Accounting is sometimes called "the language of business",
and I think that is a nice analogy, because language develops
without any absurd French-style body trying to tell us what we
should be using in our language. It gradually evolves, and that
is very healthy. The second point I want to make is about share-based
payments. Mr Cooper has done very well, and I congratulate him,
to pick a standard whose content I happen to agree with, but let's
not forget that when the Americans tried to introduce it in the
early 1990s, the American Government stepped in and prohibited
it. That is one of the dangers of having a single standard-setting
body. It makes it much easier for—forgive me, gentlemen—politicians
to interfere. If you have lots and lots of independent people
trying to decide how to prepare accounts, it's very hard for Governments
to know how to interfere.
Q462 Lord Best: Yes, staying with
comparisons with the US, Tony Blair has said that the Sarbanes-Oxley
Act was a bonanza for accountants and auditors, the very people
who created the problems in the first place, as he said. In your
opinion, is regulatory capture by the accountants of auditing
regulations and by auditors of accounting standards a genuine
concern?
Professor Myddelton: My concern is exactly the
other way around: not that the regulators get captured by the
accounting firms, but that the regulators ignore the opinions
of the accounting firms. I will quote just one small bit. When
the accounting standards board in this country issued its draft
Statement of Principles for Financial Reporting in 1995,
the then six main accountancy firms all had very serious objections,
which I summarise in the book, which Mr Marshall kindly referred
to, called Unshackling Accountants. Let me just quote Price
Waterhouse. This was at the end, summarising all their comments.
Price Waterhouse said: "Our reluctant conclusion is that
the board must start again". Now, that's pretty devastating
criticism. But the ASB took virtually no notice of what these
six leading accountancy firms had said. So my position is that
the so-called principles, the basis for thousands of pages of
regulation on which accounting standards are now based, are not
generally accepted, and that that is a serious problem. Accounting
standards are being imposed that many, many people in business
do not agree with. I'm chairman of a charity, the Institute of
Economic Affairs, and it bitterly concerns me that I can't ensure
that we present our accounts in the way I think we should—I'm
a professional accountant: 50 years a chartered accountant this
year—because I have to follow a standard that tells me how
to do it even if I disagree with the standard. Of course, this
is where academics have an enormous advantage over mere auditors
or finance directors. Academics are allowed, even encouraged,
to think for themselves, whereas if you are a finance director
or an auditor and you don't happen to agree with the standard—too
bad, you've just got to obey orders. That strikes me as an unsatisfactory
basis for a profession.
Mr Marshall: Could I also have a go at answering
that? I suppose the nub of your question really is: are auditors
or accountants overrepresented on these standard-setting bodies?
I think the principle issue with Sarbanes-Oxley was auditing standards
and, in fact, the necessity of auditing controls within American
companies. The PCAOB, which sets those standards, is entirely
full time. There are no practising auditors on it. Similarly,
on the IASB—and Mr Cooper can talk for IASB himself—there
are no practising auditors or accountants. They are, again, all
full time. There are a number of practitioners on the International
Auditing and Assurance Standards Board. I think that 50% of that
body are practising auditors, and I think that the FRC has proposed
or tried lobbying for fewer practitioners on that board. It is
important, though, that you get the benefit of practising auditors
involved on that, but perhaps not to the extent of 50%.
Mr Cooper: I just wanted to say that the IASB
is an independent body. I am one of 15 members of the board from
10 or 11 different countries, a whole variety of backgrounds.
I have an investor background, but we have regulators, people
with audit experience, finance directors, and we are full time.
We are not tied to anyone. We are not representing anybody. We
are not tied to any interested party. The whole idea is that we
are appointed from a diverse range of geographical and business
backgrounds, we are independent and take decisions in an independent
transparent manner with appropriate, very public, due process.
Professor Myddelton mentioned share-based payments—yes,
that standard—and that some aspects of accounting have been
bitterly opposed. That's very true; share-based payments were
bitterly opposed. The very fact that we are an independent international
body enabled us to get that through. I think most people now believe
that that was a good standard and that it did the right thing,
but at the time there was enormous lobbying—particularly
from the technology industry that made extensive use of these
payments—against recognising these things within the financial
statements. In terms of regulatory capture, we are certainly not
captured by the auditing profession. We obviously meet the auditors
on a very regular basis. We meet with the technical partners.
Clearly, they are the ones who have to interpret the standards
that we issue and apply them in practice. It's vital that we make
sure that we meet them. We certainly don't ignore their opinions.
Their opinions are very, very important. We are at the moment
going through, I think, 700 comment letters from around the world
on our insurance proposals. Four of those came from the Big Four
auditing firms, and quite clearly those four particular letters
will be scrutinised very, very closely, and we will meet those
people. They will participate in our working group meetings. So
we have extensive consultations with them, but we certainly are
not captured by the audit firms. I for one have never worked for
one of the Big Four, and a number of other members on the board
haven't either.
Q463 Lord Tugendhat: I was very interested
in Professor Myddelton's tirade—I put that in a friendly
fashion—against what might be termed the "slavish application
of standardised rules" rather than the application of judgment,
but I wonder to what extent he thinks the standardised rules are
an inevitable corollary of the globalisation of business. When
40%, 50%, 60% of a British company can be owned by foreign shareholders,
likewise a French company or any other, where the accounts are
perused by shareholders in different jurisdictions and where the
regulators are in different jurisdictions, in those circumstances,
is it not the case that standardised rules are the corollary of
that? I am not saying they are; I am searching after an answer.
Professor Myddelton: It may be that you can
have competing potential rules, and any individual international
group could pick one of those and apply that to all the companies
and subsidiaries in its group, but I think the essential problem
is that there isn't a single correct answer. The ultimate question
is whose judgments should rule? Should it be the standard setters,
or should it be the people running the company, subject to the
acquiescence of their auditors? One of my main objections to compulsory
accounting standards is nothing to do with the technical content;
it's to do with the effect on the public. It raises expectations.
People sort of assume that all these experts are almost guaranteeing
that these accounts are correct. That's a million miles from the
truth, as I'm sure both the standard setters will agree. Nevertheless,
that impression is allowed to exist. If people were a lot less
ready to believe accounts and were able to realise how difficult
it is and that if we don't do it quite right this year, maybe
we will next year, we'd learn more. There is no point looking
at a single year in the life of a company. That's hopeless. One
has to look over a much longer period. So to me, the most important
thing is not comparability between one company and another, which
I regard as unachievable in any case, but consistency within a
single company or group over time so that a shareholder, looking
at the accounts over a period of years, can be reasonably assured
that the same accounting methods have been used every year. Otherwise,
you can get into the kind of problems Mr Cooper was talking about
of deliberately being overprudent one year so you can borrow back
some of the profits that you've not made in the next year. That
would be very unfortunate.
Mr Cooper: It's perfectly true that a false
sense of precision is something that we want to avoid in financial
statements, and it's very important that we provide the users
of financial statements with appropriate disclosure about the
degree of subjectivity; the uncertainty in the measurement—for
example, loan loss provisions; the uncertainty in some of the
valuations of difficult-to-value assets; the risks that companies
are running through the positions that they take. There is extensive
disclosure; many people say too much disclosure. We are constantly
criticised by putting in things that increase the length of annual
reports, but we put these things in precisely to avoid this false
sense of precision problem that Professor Myddelton identified.
I would say that the real push for globally comparable financial
statements comes from the investment community. I worked as an
investor and as an adviser, and before 2005 it was just horrendous
in Europe. The whole idea of trying to compare a French company,
a UK company and an Italian company was just completely impossible.
There was no transparency. You knew that different accounting
systems were being used, but it was very, very difficult to really
identify the effect of that. It was just a real brake on the willingness
of people to invest internationally, so the whole idea of the
international accounting list is to promote that greater flow
of capital and people's ability to make these comparisons on a
level playing field.
The Chairman: I think we must move on.
We have time for just one last question, Lord Levene.
Q464 Lord Levene of Portsoken: A
paper in the journal of the Institute of Economic Affairs argued
back in 2006 that government intervention has stifled competition
in the audit market and is responsible for the market concentration.
Do you agree that adoption of complex standards and regulation
are causes of that concentration?
Mr Marshall: I think that standards have become
more complex as businesses have become more complex, so I don't
think that more complex standards have just come in on their own.
Those more complex standards do, though, require more skills from
auditors. When I started as a very junior auditor, you might have
got the tax department to come and look at the tax provision but
that was about the only outside expert you might have needed.
Now you're getting share option valuation experts, pension actuaries
and financial instrument specialists, so I think that the more
complex standards, which were caused, I think, by more complex
business, do bring in the need for an increased range of skills.
That probably tends to push up the optimum size of audit firms,
because they do need these specialists.
Q465 Lord Levene of Portsoken: Is
that caused by government intervention?
Mr Marshall: I don't think so. I think that
auditing standard setters and regulators have obviously raised
the bar on what auditors do, particularly on what they have to
document. Auditors spend quite a lot of time now not only auditing
but documenting what work they've done and the judgments they
make. That sort of quasi-government intervention has done that,
but I think it's really the more complex business world that is
causing the increased complexity of auditing.
The Chairman: No other comments. Well,
gentlemen, thank you very much indeed. I am sorry time has prevented
us from going on longer, but it has been very helpful to have
you. Thank you.
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