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December 2009

Bring back substance

By Uday Chitale, Murtuza Vajihi, Chartered Accountants
Reading Time 3 mins

Accountant Abroad

When ‘true and fair’ accounts disclose either favourable
results that are factually unsupportable, or a position much worse than
warranted due to an ‘accounting quirk’, with no bearing on actual performance,
we are bound to wonder what is going on.

Arbitrary losses may arise when a company is forced to
separate its foreign exchange credits from the transactions that they cover,
even when inventory is costed at the FE rate for all decision-making purposes.
Or results may be burdened with the ‘value’ of options granted to a company’s
directors, when all we ever wanted was a note on the options granted, their
pricing, and how much they made when exercised. Worse, if the company cancels
the options, the grant cost allocable to future years becomes an immediate
revenue hit, even though it will never actually be paid.

A deferred tax ‘liability’ arises with virtually every ‘fair
value’ revaluation (even when there is no intention to sell), despite deferred
tax not being a liability at all under the International Accounting Standards
Board’s own definition.

The requirement to split land and buildings in property
revaluations, to calculate deferred tax on only the building portion of the
revaluation, then split that portion between ‘recover through use’ and
‘recover through sale’ and apply different tax rates over different time
horizons, is enough to convince you that we are dealing with the ramblings of an
unhinged mind.

Little wonder that we come across instances of exasperated

A note in the accounts of one public company: ‘In view of
the size of the property portfolio, and the complexity of determining the
residual value and anticipated sale dates of these properties, and the fact that
any deferred tax liability raised will be offset by deferred tax assets,
management believe that an exercise to determine the requisite amounts would
require expenditure well in excess of any expected benefit.’

Arbitrary and indiscriminate :

The reverse effect can arise too. British Telecom’s pension
fund deficit doubled to £ 5.8 bn in the second quarter of 2009. Yet its IAS 19,
Employee Benefits,
‘mark-to-market’ measure of liabilities showed a £1 bn
improvement ! Said a spokesman : ‘While BT is obliged to report the IAS
19 figure each quarter, it has no relevance to the funding of the
To what, pray, does it have relevance ?

Banks continue to be the main beneficiaries of
‘compliance-generated’ profits. Years ago Enron showed that the most deceitful
words in the accounting lexicon are ‘off balance sheet’, yet banks still dodge
toxic asset impairment recognition by using credit derivatives held in
off-balance sheet vehicles.

General Electric in the US agreed in July to pay a settlement
of $ 50m (£ 30m) without admitting or denying wrongdoing following Securities
and Exchange Commission allegations that it fiddled its accounting repeatedly,
to preserve its reputation for ‘making the numbers’.

The SEC refers to discoveries by inhouse accountants of
misstatements that more senior executives ordered them to ignore. Two (out of
four) violations descended to the level of fraud, including an Enron-type scheme
to inflate profits by booking phony sales. In none of these cases has there been
a breach of standards or a murmur from the auditors. Yet giving such accounts
the true and fair imprimatur insults readers’ intelligence. The abiding
principle of preferring substance to rule-based form has all but been abandoned.

Our accounting rules have descended into farce and do not
lack mirth; however, they utterly lack commonsense.

Excerpted from an article by Emile Woolf
(Source : Accountancy, October 2009)

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