The Hindu Business Line : `Criminal conduct could be concealed in a thicket of detail'

IN THE accounting terrain, it is just one more routine day. Because there are enough stories of accounting going astray in recent news, as if to match the crime reports in the city pages. For instance, "Visco, false accounting will be `yet another scandal'," reads Agenzia Giornalistica Italia. "Given the loose accounting rules for the cards, they can easily be used to goose the bottom line," reads a column titled `Hazy Mess of Gift-Card Accounting' in Forbes.

There's more: `Many accounting firm managers break policy: audit,' informs Globe and Mail, Canada. `Two Fined in Lucent Accounting Scandal,' says CFO.com. `UMC fined for late reporting of accounting error,' states Infoworld, the Netherlands. `Accounting quality affects stock prices,' informs Philadelphia Inquirer. `Accounting Devils Hide in Footnotes,' alerts Minneapolis Star Tribune. `Latest audit shows accounting errors,' reads a headline on Freeport Journal Standard. And SmartPros Accounting says, `WebMD Execs Charged With Accounting Fraud.'

Image boosters

Don't lose heart because www.aicpa.org, the site of the American Institute of Certified Public Accountants, informs that according to Gallup's annual update on the images of various business and industry sectors in the US, accounting is on the rise, compared to 2004. "The current score for the accounting sector is up eight points from last year."

A few months ago, the AICPA had commissioned Penn, Schoen & Berland Associates for an independent `image research'. What were the findings? That the CPA profession continues to garner high marks from business decision-makers, executives and investors, earning favourable ratings of 97, 95 and 89 per cent, respectively! "In fact, business decision makers and executives ranked CPAs higher than physicians by several percentage points. CPAs also ranked higher than other financial services-related professions, such as insurance agents, bankers, chief management consultants and stock research analysts."

It seems that CPA `heritage' attributes — such as "committed to the rules of the accounting profession," "reliable" and "consistently demonstrates integrity and ethics" — are getting better ratings. These values are `the bedrock of the CPA reputation,' notes the Institute. Something for the accounting tribe to cheer closer home too, for the possible rub-on effect on the profession at large.

The survey had sought response to one more tricky question: Whether CPAs and the accounting profession have taken steps to fix the problems that had led to past accounting scandals. "Eighty per cent of business decision-makers and 70 per cent of executives said `yes.' While just 52 per cent of investors said `yes' to that question, 71 per cent of investors responding to the survey admitted they are not familiar with the Sarbanes-Oxley (SOX) Act," reads a press release from AICPA.

Another morale-booster on the site is about a new study by Robert Half International, Next Generation Accountant: A New Outlook on a Timeless Profession. It says that new accountants have `a bright future' ahead of them! "The study shows there will be myriad opportunities for those who can help companies meet compliance requirements and support business expansion projects," adds www.aicpa.org.

Unlike lawyers, journalists and politicians

These positives are a few months old but what is of interest is that Christopher Cox, Chairman of the US Securities and Exchange Commission (SEC), cited the percentages when speaking at the AICPA National Conference on December 5. "A growing economy needs the accounting profession," he said. "CPAs enjoy a solid reputation among the public, and among business decision-makers. That's a testament to your integrity and professional competence — or perhaps it's because all the television programmes are about politicians or lawyers or journalists," he added in half-jest, in the speech available on www.sec.gov.

These other professionals — that is, lawyers, journalists, and politicians — get consistently low marks in public opinion polls, said Cox. "Accountants, in contrast, are seen as steady hands," he added. "Business executives — your clients — give you a favourability rating of 95 per cent," noted Cox. "At the SEC, where we're focused on investor protection, we're most impressed that investors give you a favourability rating of 97 per cent (?). That's as close to perfect as you're likely to get in this life." Let this not make you complacent, reminded Cox. "You have a reputation, and a future, to protect. Together, we've all got to remain vigilant," he exhorted.

Why quadropoly?

One of the three major issues that Cox touched upon in his speech was about the dominance by the Big Four, leading to "lack of competition in the market for audit services for large public companies." He pointed out how the AICPA, founded in 1887 and now with approximately 3,50,000 members, had `so much diversity and talent' in its ranks. "Must it be that only four firms serve virtually the entire market for audit services for large public companies?" asked Cox. "Why is this market an `oligopoly,' in the words of the Government Accountability Office?"

He then cited the facts: "The Big Four firms audit 80 per cent of all the public companies in the US. Their audit clients account for 99 per cent of all public company annual sales in the US." These statistics imply "significant barriers to entry in the market for audit services for large public companies," he observed.

"Investors have a significant stake in the development of a much more broad and competitive market for auditing services," declared the SEC chief. "If a quadropoly has emerged, it's fair to ask if that's because of the way the rules are written. We must also ask ourselves whether we can rewrite our rules to eliminate barriers to entry for new competitors in the large-company auditing market."

While that could have irked the majors in the profession, Cox recognised the importance of the non-Big Four by stating, "The Commission staff have found that there are many medium and small accounting firms that provide high quality audit services." It's easy for audit committee members to find information about these firms, informed Cox, and gave the example of `significant portions of their inspection reports' available on the Web site of PCAOB. (The Public Company Accounting Oversight Board, as www.pcaobus.org enlightens, is a private sector, non-profit corporation created by the SOX Act of 2002, "to oversee the auditors of public companies in order to protect the interests of investors and further the public interest in the preparation of informative, fair, and independent audit reports."). One wonders what prevents Indian regulators from making such forthright statements in support of our medium and smaller audit firms.

XBRL - Extensible Business Reporting Language

Cox spoke also about what according to him is `top priority': XBRL or Extensible Business Reporting Language (www.xbrl.org). "XBRL will do for business reporting what bar coding did for product distribution," prophesied the SEC boss, and listed many benefits of `the interactive data' as follows:

Vast improvements in the quality, timeliness, and usefulness of information that investors get about the companies they're investing in.

Better tools for SEC analysts to detect fraud.

Easier, less expensive, and less time consuming for companies — and their accountants — to comply with SEC reporting requirements.

Possibility of automating a significant part of the SOX 404 work.

Help for auditors to test the integrity of internal controls over financial reporting by examining the application of the data tags themselves.

Assistance for issuers in developing risk-based approaches to assessing and testing internal controls.

"Some day, the ability of investors and analysts to render financial information in any format they choose could help us reach the promised land of international accounting convergence far sooner than we could otherwise have hoped," is a dream that Cox shared with the accounting audience.

Let's make accounting less complex

A key theme in Cox's speech was his plea for simplified accounting rules. Mentioning that the SEC is encouraging `a major national effort to make accounting less complex,' in collaboration with the PCAOB and the FASB, Cox sought the help of the AICPA too, and said that the effort needs inputs from the regulators, the government, the academy, and also the profession. (FASB is short for Financial Accounting Standards Board, "the designated private sector organisation in the US that establishes financial accounting and reporting standards," as www.fasb.org informs.)

"From audits to financial reports, we're looking for recommendations on how to make the rules and their application much more clear, straightforward, and transparent," Cox outlined. "The accounting scandals that our nation and the world have now mostly weathered were made possible in part by the sheer complexity of the rules. Criminal conduct could be concealed in a thicket of detail. Conformity to hundreds of technical rules became not a shield to protect investors, but a sword to be wielded against them," he analysed.

The complexity of modern financial transactions often calls for a commensurately detailed set of regulatory requirements, conceded Cox. "But the sheer accretion of detail has, in time, led to one of the system's weaknesses — its extreme complexity. Convolution is now reducing its usefulness," he rued.

The serious question, Cox explained, is whether preparers and auditors can produce the transparent financial information that our capital markets require. He then gave `a synopsis of some of the steps being taken' by the FASB. Such as:

Reassessment of specific standards in major areas where rules fail to provide transparent information.

Efforts to codify all of the existing literature, in order to establish a single source for all GAAP material.

Efforts to contain the proliferation of new pronouncements from multiple sources.

"Plain English is just as important in accountancy as it is everywhere else where investors are concerned," said Cox.

On the simplification idea, however, catch up with the scathing attack by J. Edward Ketz, accounting professor at The Pennsylvania State University, and the author of Hidden Financial Risk. His opinion titled Cox Encourages Simpler Accounting: Bah, Humbug! on http://accounting.smartpros.com notes: "With all due respect, Mr Cox, you have revealed an incredible ignorance about the spate of accounting scandals." Ketz writes, "Principled-based accounting requires principled people for it to work because principled-based accounting will be easier to manipulate."

Accounting scandals were made possible by managers who exaggerated and abused accounting numbers until the reported numbers made them look good, he points out. "Aiding and abetting this process of `earnings management' have been board directors who never asked serious questions, corporate lawyers who were eager to push the limits, stock brokers and investment bankers who did not care how they made a buck, financial analysts who worried little that they served as used-car salesmen for their investment banking firms, auditors who looked the other way, an impotent FASB, an overextended SEC, and members of Congress who have tolerated almost anything for sufficiently large campaign contributions," Ketz charges.

Pillars of strength

To wrap up however on a happy note, to match the festive season, let me reel off a few snatches from the concluding part of Cox's speech: "We will need more, not less, help from accountants... In the 21st century as much as the 19th, our nation desperately needs you... Each of you, and the noble profession you represent, are pillars of strength for the most productive and strongest economy on earth. Thank you for what you do, and for continuing to place the interests of investors first."

Feeling dizzy?

AccountSpeak@TheHindu.co.in

D. Murali

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