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The `brave new world' of bean-counters
November, 16th 2006

As investors you might have occasionally suspected if the financial information that you get from companies is relevant to you. Now the doubts have been confirmed by no less than the global accounting majors. `Increasingly irrelevant to investors,' is how a recent vision paper from the world's big six firms describes `the current financial reporting model'.

The primary purpose of company reporting is to empower investors, says the paper; because it is investors "who, through the purchases and sales of securities, drive the growth of capital markets and economies around the world." So, the new model should be forward-looking, driven by the wants of investors, argue PricewaterhouseCoopers, KPMG, Ernst & Young, Deloitte, BDO International, and Grant Thornton.

Their new reporting model goes beyond the usual financial to the non-financial realm, to help gauge `how well a company will perform in the future'. Such as, measures on "innovative success (perhaps measured by patents recently awarded), measures of customer satisfaction, product or service defects or awards, and measures of employee satisfaction (approximated by turnover)."

The paper, Global capital markets and the global economy: a vision from the CEOs of the international audit networks, isn't the first in the US to highlight the need for a new reporting framework. The Jenkins Report of 1991 had suggested the disclosure of metrics on product reject rates, market share, customer acceptance, and so on. In 1998, the FASB (Financial Accounting Standards Board) had launched an industry-wise exercise on similar lines.

Closer home, one can trace the keenness to look beyond the mere financial terrain to more than four decades back, when the Daphtary-Sastri Committee had studied the tragedy of how the investing public lost heavily by contributing capital to companies which indulged in shady practices that normal audit didn't uncover. As a result, Section 227 of the Companies Act was amended in 1965 to insert a new sub-section 4A, whereby the Central Government was given powers to direct additional points that the auditors' report should contain.

MAOCARO, or the Manufacturing and Other Companies (Auditor's Report) Order, 1975, and its successors in 1988, and the CARO in 2003, are only too well-known for their emphasis on non-financial aspects. For example, the points on which an auditor had to report included the reasonableness of physical verification of assets and inventory, existence of internal control and internal audit.

The tagged new formats

Reverting to the `brave new world' vision of the audit networks, you may be startled to know that the old formats balance-sheet, income statement and cash-flow statement may well be trashed. New formats can be developed by the profession, analysts and users, hopes the paper. "In such a world, the tagging process or the system used to put information in different categories becomes paramount." XBRL or Extensible Business Reporting Language can be the enabler in tagging and categorising, opine the firms. "Once the data are so formatted, users can retrieve them, put them in any standard spreadsheet software, and then view or manipulate them in any way they want."

To the users of tomorrow, the present audit mould may not hold good, it seems. "The current audit opinion is like an `on and off' switch: "either a company's financial statements do or do not comply with prevailing accounting conventions." There is no `in-between', rues the paper.

"Just as most of us have become accustomed to the use of rheostats to finely adjust the volume of the music we hear or the intensity of light in our homes, users of financial information may demand from public companies the ability to receive more finely nuanced opinions from auditors about the degree of a company's compliance with a given set of standards, or the relative conservatism of judgments compared to peer groups."

That should be music to investors, though auditors may find the idea jarring. "More boldly, investors even may want the auditor's views about the overall health and future prospects of the companies they audit. Regulators and the liability system in any country should accommodate these types of requests," adds the paper.

However, what should make accounting professionals happy are the suggestions on uniform audit standards, apart from convergence of reporting standards. "The US litigation environment has driven preparers of financial statements and auditors to want and, in turn, accounting standard-setters to develop, `rules' based standards." The stress is on detail, at the cost of judgment, turning the auditors, in the process, to mere box-checkers. "Rules increase complexity and actually can decrease the meaningfulness of information."

The rule risk

Isn't it risky to rely on judgment? No, say the accounting firms. "Excessively detailed accounting guidance and the checking of audit boxes it generates provides only a veneer of reliability and relevance." More dangerously, "The companies whose accounts are being checked in this manner may comply with the letter of the rules but not their spirit." And the investors may infer financial soundness in companies, which in fact are hollow!

Makers of accounts in companies have more things to fear than the likely jettisoning of the comfort that rules provided. For instance, the paper talks of `real-time access to financial and other information' to get rid of short-termism. And forensic audit, both regular and random, as `the most aggressive, but costly and intrusive way of rooting out fraud'. Forensic audit is akin to police investigation, describe the accounting firms. "Forensic auditors scrutinise all records of companies, including emails, and would be able, if not required, to question all company employees, and to require statements under oath."

The vision document wraps with these lines: "The world is rapidly changing. Let us begin the conversation. It promises to be lively." Sounds too glib to be taken seriously?

D. Murali

 
 
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