The stately dance continues

The IASB and FASB have today published the definitive (for the moment) chapters of their joint conceptual framework for financial reporting. The project, which is supposed to lead to 'internally consistent' standards is already so riddled with contradictions that it has little credibility. However, the long extended search for a framework allows the standard setters to defer awkward questions almost indefinitely.

The latest twist [1] is the assertion that the purpose of financial statements is to

'To provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions about providing resources to the entity.'

The irony of this is that most equity investors never provide any financial resources to an entity. They buy and sell second-hand shares. When new resources are supplied to an entity, more information, by way of prospectuses and so on, is created that supplements financial statements.


[1] Well I assume the final document includes this phrase. At the time of writing I'm relying on a previous document as I don't have access to the actual document; it is not freely available - one has to pay for a subscription to get it.

A new financial statement? Or an old one?

David Tweedie has apparently confirmed that the IASB is considering including a 'regulators'' page in financial statements so that people concerned with financial institutions can be given the information they need to ensure market stability. It's quite likely that this will include something that looks very like a historical cost balance sheet, and so, rather being something new, this might signal a return to something old.

This could be a fascinating accounting experiment and would give standard setters an opportunity to find out what information is actually demanded, has impact and has value relevance. I foresee the growth of a minor industry in researching the relative importance of regulatory and 'decision useful' information.

More on Lehman's

Our growth in understanding what went on at Lehman's proceeds apace. Despite the criticism of financial transactions that occurred in London, it seems the accounting that is at issue occurred in the USA. It's said that because the Repo transactions involved exchanging assets worth more than $105 for every $100 of cash received SFAS 140 permitted them to be treated as sales because Lehman's wouldn't have had enough cash to buy them back again.

Layers of the onion

The Lehman collapse has been blamed as the crucial event in the credit crunch but now it is revealed that aggressive accounting had been hiding problems for some time. The device that it is alleged was used to manipulate the financial statements was accounting for repo (repurchase) transactions.

In a repo an asset (a block of loans, say) is exchanged for cash, and the exchange reversed some time later. In substance this is usually a short term loan with the asset being used as collateral.

It's alleged that Lehman's were accounting for these as sales so that the asset disappeared off the balance sheet and the cash was used to reduce net borrowing. The effect is to reduce the bank's reserve ratio to within acceptable limits.

How was Lehman able to count these transactions as sales rather than loans? How was it able to exploit the provisions of the relevant US accounting standard, SFAS 140? It is likely that Lehaman's did so by a piece of cheeky financial engineering whereby the transaction took three stages, with the asset going back and forth to the counter-party three, and ultimately, four times. The title link shows how this is done.

What we don't yet know, is why this had to be done in London, the role of fair value, whether the financial reporting in the UK reflected the same things as the American accounting, and whether the accounting was routed through off-shore vehicles.

This one will run and run.

Success in Doctoral Studies

At a recent research forum the following success index for PhD studies was proposed:

PhD Success Formula

S= (HW + 3M + NR/4)xC/A
___________________
(1 + FM + FB/10 + S)

Where: HW= Hours worked on thesis

M = meetings with supervisor

NR = number of references

C= Average number of cups of tea/coffee per day +1

A=Average units of alcohol per day + 1

FM = ln(Number of family members)

FB= Number of Facebook friends

S= Number of Sports teams supported + 4 x Number of sports played regularly.

While this is clearly an early attempt at a descriptive index related to probability of success it indicates the need for further research to improve the functional form and parameterisation. One commentator has already suggested that comsumption of illegal drugs should be added into the measurement of A, for example.

Mintzberg on Bonuses

In an article in the Wall Street Journal (click on title link), management guru, Henry Mintzberg, questions whether directors' bonuses are necessary at all. A very timely question, in my opinion. There is little evidence that bonuses create long term value or that managerial talent is in very scarce supply. My personal preference would be to pay CEOs a fixed multiple of the average salary in the organisation. At least it would stop directors pay increasing faster than the average and it would be an incentive for companies to give a better deal to their low paid workers.

Politicisation of Accounting Standards

The article in the title reports the Association of British Insurers bemoaning the EU's refusal to endorse IFRS 9 'Financial Instruments'. ABI spokesperson, Paul Vipond, regrets the 'politicisation' of accounting standards.

Is politicisation such a bad thing? Standard setters are in business making rules about how companies keep score. These rules can have real economic effects that make some people better off and some people worse off. For example, many people hold the pensions standards partly to blame for the demise of final salary pension schemes. Now, this kind of decision about wealth transfers is quite rightly in the political domain - our elected representatives should be the people making these decisions, not a private and largely self perpetuating organisation, such as the IASB.

The IASB likes to pretend that its work is purely technical and that it is devoted to improving the way that financial statements 'tell things as they are' so that decision makers are more fully informed. By denying that accounting standards involve choices that affect individuals and companies, the IASB attempts to avert criticism about its legitimacy.

If IASB were doing its job properly it would be looking at the likely economic and social impact of its standards.