Commentary: A map for the accounting jungle

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The Independent Online
There is undoubtedly something rotten in the state of company accounting. If annual reports presented an accurate and incontestable picture of a firm's performance, the City would not have been shocked by the collapse of apparently sound and profitable businesses such as Coloroll or British & Commonwealth.

But accounting, if not actually one of the creative arts, is certainly an inexact science. The fact that the rules have been drawn up - too often, all too loosely - to suit a wide variety of businesses and transactions means that it is easy for companies, reputable and unscrupulous alike, to flatter their figures.

Judging by the controversy Terry Smith's book Accounting for Growth has aroused, it should provide a handy guide. It tries to help investors find their way through what Mr Smith describes as the accounting jungle, 'a jungle with many species of animal - some benign, some carniverous'. He describes the 13 most common accounting dodges, ranging from the use of provisions to off-balance-sheet financing - and illustrates how they are used in a company's accounts.

It is undoubtedly a rich seam, but Mr Smith's evident enthusiasm for the subject translates into a breathless style, in which he runs at breakneck pace through scores of profit and loss accounts, balance sheets and notes highlighting dodges and accounting sleight of hand.

His determination to leave no company unscathed means that virtually every point is hammered home with many examples. The flood of detail, however, means that for all but the aficionado of accounting-speak, the message behind the massaging may often be lost.

Mr Smith offers a list of 'survival techniques'. But this is disappointing, giving little clear guidance on how to sort out the corporate saints from the collapsing sinners.

In his introduction, Mr Smith says his aim is to 'prevent you from losing money in investment' - a laudable, if ambitious aim. But, by relying too heavily on examples - all outlined with varying degrees of opprobrium - Mr Smith gives the impression that none of the techniques can be legitimately used. Yet, he devotes a chapter to a checklist, scoring Britain's large corporate companies on the basis of how many of the techniques they use. Only four - BPB, CRH, Rugby and Glaxo - score nil. A more useful list would surely pick out the particularly enthusiastic transgressors.

His eagerness to root out corporate culprits also undermines the strength of much of his research. Dealing with contingent liabilities, he cites Allied-Lyons, which admitted last March that it had lost pounds 147m on foreign currency hedging.

'Why was this massive foreign exchange transaction not revealed by the contingent liabilities note (in the accounts for the year to March 1990)?,' he asks. 'Because contingent liabilities by definition do not form part of the double-entry bookkeeping system which is at the heart of all accounting,' he tells us.

The latter statement may be correct, but it is not the reason for non-disclosure by Allied-Lyons. In fact, foreign currency hedging is in the books. The costs of hedging, and settlement when it expires, are paid for in cash. What happened was that management got it wrong. Tightening accounting rules would not have stopped the problem; indeed, they ensured it could not be covered up.

His determination to blame the accountants comes through most strongly in the chapter explaining the demise of Coloroll and British & Commonwealth, one of the best in the book. But his description of the facts leading up to the demise makes it clear that their collapse was less to do with accounting than with the acquisitions mania of the 1980s. Both had to take full advantage of the accounting breaks available otherwise the deals would simply not have added up.

The market realised that, long before the accounts describing the results were available; B&C's shares started to slide as soon as the Atlantic deal was announced, and underperformed the market by 50 per cent in the following year. Coloroll's performance was, if anything, worse. Yet it is unlikely that either deal was spurred by the ability to use creative accounting techniques.

The fact that Mr Smith has been suspended by his employer, UBS Phillips & Drew, shows that accounting is a sensitive issue. The profession, too, has realised it needs to clean up its act and is starting to introduce new, much tougher, standards. If Mr Smith's book also serves to make more companies more honest in their presentations, it will have performed a valuable role.