How lobbying has skewed national figures

Accountants have tried for years to find a common language that would allow users of financial statements to make comparisons between companies operating in different parts of the world.

In an ideal world, an investor in London would be able to compare the financials of a company in New York with the same surety as one in Tokyo or Lagos. As capital races around the world, those pushing the buttons want a common language to understand whether a profit is measured the same in China as in the UK or US (it isn’t).

The goal of a universal language for accounting remains elusive – and, like much else in the world of big money, prone to lobbying by large corporations and their accountants.

Influence

“Just a small change in accounting standards may substantially alter the flows of economic benefits to affected parties,” according to a study on lobbying to influence accounting standards published in the Copernican Journal of Finance & Accounting.

“These may have strong incentives to influence the process of standard setting. Competing goals create conflicts about the content of accounting standards.”

A University of Naples study found the lobbyists’ success “is linked to the impact that the respondents have on the viability of the IASB [International Accounting Standards Board]”.

In other words, the bigger the organisation, the more likely it is to sway the standard setters.

The IASB is the body charged with formulating International Financial Reporting Standards (IFRS). More than 130 countries, including SA, followed the EU’s lead in adopting IFRS from 2005. Companies in the US apply the Generally Accepted Accounting Principles (Gaap).

The main difference is that Gaap is rules-based and IFRS is principles-based.

Rules are more rigid than principles, yet both standards purport to offer transparency, consistency, accuracy and honesty.

That sounds reassuring, but investors in Tongaat and Steinhoff will be left wondering where these standards deserted them.

Read: Steinhoff, Tongaat woes raise South African auditor scrutiny

In Tongaat’s case (to take just one example), a self-serving interpretation of the revenue recognition rule – IFRS 15 – meant land sales were counted before they were hatched.

Accrual accounting allows revenue to be recognised where a transaction has been concluded, though payment has not yet been made. Because revenue is not the same as cash, this allows an element of judgement to creep in. IFRS 15 says the risks and rewards of ownership must pass from the buyer to the seller, and there must be a reasonable assurance that payment will be made before revenue can be counted.

Land sales are notoriously convoluted, particularly where development is involved, and payment can be delayed for any number of reasons, such as zoning approvals. In Tongaat’s case, revenue appears to have been concocted out of thin air, to the benefit of the then directors’ bonuses.

Read: Will a firmer hand on the audit profession restore its credibility?

Joel Litman of US research house Altimetry analyses investments by reconstructing published financial statements to account for distortions introduced by Gaap and IFRS (for example, adjusting for the different ways companies account for stock). He has identified 130 such distortions that, when adjusted, provide a more consistent basis for investment comparison.

In many cases, says Litman, published financial statements are all but useless.

If that’s the case, the goal of a common accounting language seems as far off as ever.

World trade and cherry-picking

Several studies show that harmonisation of accounting standards, however imperfect they have been applied, has been a benefit to world trade.

But some, it seems, are benefitting more than most.

Some countries adopting IFRS have chosen to leave out those parts that don’t suit them while others, like China, chose to stick with local accounting rules with an undertaking to eventually move towards internally recognised standards. This explains why many analysts distrust Chinese financial statements, and are equally sceptical of its nationally reported figures.

The Big Four

Richard Brooks – author of Bean Counters: The Triumph of the Accountants and How They Broke Capitalism – points out that the accounting standard-setters are swimming in alumni from the Big Four accounting firms, ensuring that the rules are crafted to suit themselves and their clients.

This lobbying has skewed national statistics and puffed up corporate balance sheets so they look more muscular when presented to banks and investors.

The recent adoption of IFRS 16 forced companies to bring formerly off-balance sheet leases back on the balance sheet. This closed an accounting loophole that allowed airlines (as an example) to operate fleets of planes without recording them on their balance sheets on the basis that they were leased, not owned. The effect was to reduce liabilities, and hence gearing ratios – which is what banks and most investors want to see.

“One of my great ambitions before I die is to fly in an aircraft that is on an airline’s balance sheet,” joked David Tweedie, former chairman of the IASB.

A PwC study of more than 3 000 companies found that the new accounting rules for leases would increase debt loads by 22%, and boost Ebitda (earnings before interest, tax, depreciation, and amortisation) by 13%. It’s not hard to see how a change in rules yielding such handsome growth in earnings for no extra work would attract the very best lobbyists money can buy.

Impact on national statistics

“The adoption of IFRS has impact on a country’s national statistics. Data on productivity, efficiency and profitability are often times collected by the government statistical authority for national reporting,” according to a study published by the Mediterranean Journal of Social Sciences.

Says Nicolaas van Wyk, CEO of the SA Institute of Business Accountants: “The way accountants prepare financial statements is not a politically neutral affair. Every year millions of companies prepare their financial statements using a set of standards developed by an international organisation, the IFRS Foundation.

“The world’s profits are literally determined by one organisation,” says Van Wyk.

“Evidence suggests [and logic would dictate] that the process of issuing and adopting these standards are subject to lobbying. Does this lobbying favour large conglomerates, special interests, Big Four audit firms, or does it potentially harm job creation and economic development in Africa?”

Various studies show the voluntary adoption of IFRS results in more volatile earnings performance, in large part because the recognition of losses is more immediate than was previously the case under local accounting standards.

Van Wyk points out that lobbying is an inevitable part of economic life, but then where are the SA lobbyists at the IASB? Accountants elsewhere in Africa are asking the same question.

“We need to look more closely at the accounting standards we are using,” says van Wyk.

“It seems we may have blindly adopted standards that were influenced by lobbyists in Europe or the US, and that these standards suit the developed countries but not us.”