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

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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