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The Bruce Column — The governor goes for common sense

  • Robert Bruce Image

23 Nov 2010

Sir David Tweedie, the Chairman of the International Accounting Standards Board, has always taken a robust view about the value of a company's management mixing up disconnected information and then trying to rely on the resulting data when taking a strategic decision.

If you or I had a £20 note for the number of times that Tweedie has told a conference, often in the context of pension accounting, that you might as well take the number of miles to the moon, multiply it by your Grannie's shoe size, and then divide it by the number you first thought of, for all the good it would do you, we would all be able to retire tomorrow.

There is a fundamental problem here. People really love the idea that complex issues, whole views of corporate and financial performance, can be reduced to one figure, one magic number. But anyone close to accounting, auditing or financial reporting knows that life, and complex corporate entities, are not like that. So it was good, last week, to find the Governor of the Bank of England saying exactly the same thing.

Mervyn King was giving evidence to the House of Lords Economic Affairs Committee, which has been looking into the audit market and, by extension, some of the confusions involved in the financial crisis. Suddenly, at the end of a complaint about the inconsistent way banking folk had used the principle of mark-to-market, he came out with a simple, common-sense statement. It may not have had the humorous and folksy effect of a Tweedie joke, but it was saying the same thing.

"The idea that there is one number which is going to accurately capture the risks and challenges facing an institution is really very silly", he said. And then he went on to say that it was wrong to blame accounting rules for the behaviour of banks. It would be inaccurate to say that rays of sunshine suddenly penetrated the windows of Committee Room 1 on the House of Lords Committee corridor. But certainly the ideas being discussed ceased to bound incoherently around the room and instead found themselves sealed in a small box clearly marked: 'Common Sense'.

This can only be for the good. Financial reporting tends to be complex because, particularly in the field of banking and financial services generally, the entities it reports on are, in themselves, ferociously complex. But that shouldn't mean that the fundamentals underlying them are devoid of common sense. Many people know this, but it doesn't stop financial institutions trying to convince the world otherwise. King pointed out that the principle of mark-to-market had been "very convenient" to people in the good times. But these same people, come the financial crisis, tried to cover up the true state of affairs by saying that they mustn't use mark-to market and so "concealing from many people the true state of losses that had arisen". There was a need, he said, for a prudent judgement of expected losses. As for how those should be accounted for, he said, that "is something I am quite happy to leave to the accounting profession".

In fact he took this approach consistently throughout. When offered the opportunity to criticise IFRS and mark-to-market measurement he refused to do so and he was critical of the idea of using the 'mark' as a basis for compensation.

Instead he homed in on banking behaviour. The accounting figures do not drive behaviour. "The fact that the accounting convention says you don't have to recognise a loss until the lack of payment has actually occurred doesn't seem to me to be a very sensible or prudent basis to make business decisions", he said. But that was not an excuse for business behaviour. "Business decisions need to be separated from saying this is what the accounts say we can or cannot do".

Very elegantly he had pulled the rug from under the feet of all those who argue that their behaviour is somehow in thrall to accounting rules.

As for the rest of his wise words he made it clear that in future he wanted to get back to a system where the Bank and bank auditors had sensible dialogue and conversations with accurate and sensible judgements about what was happening in the market and which highlighted any risks that might be scurrying in from over the horizon.

But in the end his message was plain. Accountants and financial reporting were not the scapegoats. In answer to the final question of the day he said it again: "The idea that there is just some magical set of numbers which in all circumstances are the only ones we want to look at is a very dangerous philosophy".

Robert Bruce
November 2010

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