The journey towards achieving fair value standards has resulted in the loss of prudence and judgment in accounting outsourcing companies. Poor audits and troubled auditors have seeped into the very heart of the corporate system and rendered it dysfunctional. Further investigation into this matter has proved that the problems in the audit market may be perhaps due to some loopholes in the accounting standards in place.
Recent financial scandals such as the fraud at the Colonial Bank in the US to the disintegration of Carillion, the UK outsourced bookkeeping services group has significantly pointed out the inefficiencies and errors in the system. One of the main problems is the structural dependency on the Big Four firms. Another problem is that auditors have failed to prevent investors from being cheated and to report criminal practices. The rules have become defunct and unnecessary for the practice.
Three decades ago, banks would manipulate their profits by valuing loans and keeping aside provisions for losses on loans without caring much about the existing economic situation. This incorrect higher scaling of profits was good news for many investors as they would get higher returns. However, these practices were detrimental to the economy leading to the savings and loans crisis of the 1980s and 90s.
What went or is going wrong
Managers who are spoilt by the equity incentives and fringe benefits are using the system for their own personal gains. The writing up of asset values in relation to market values, whether real or estimated, have enabled them to get profits, distribute dividends and increase share prices. The fair value system will only work if correct market valuations and proper estimates based on logic are prepared. The credibility of the company is what’s at stake and an auditor’s responsibility is to guard that.
However, auditors, especially in the Big Four firms, have shed that responsibility, instead of using their lobbying power to make decisions devoid of any judgment. This is where one of the drawbacks of the fair value approach creeps in. Rationale and prudence can only be restored if time is taken to understand the different uses of the models, estimates, and projections. This will help work around the manipulative nature of the historical cost approach.
There is always a place for new rules and approaches in the market. The problem of non-performing loans in Europe has been dealt with by creating a new rule, IFRS 9. The rule mandates that companies set aside bad debts provisions before incurring any losses, in order to be on the safe side. The rule is a healthy mix of fair value accounting and predecessor standards.
Principles of modern accounting
An important principle of modern accounting is fair value. The framers of accounting standards suggest the coordination of accounting rules globally and to do away with system loopholes. This method relates asset valuations with the prevailing market prices. The aim is to prepare accounts according to the current economic situation rather than the historical cost of the assets. It has since been accepted as a fundamental concept in modern accounting. The method has been adopted in the European accounting practices as well. The concept stems from the idea that accounts should be user-friendly. It has been used for volatile and fictitious valuations and extends to non-liquid assets with no certain market price.
This rational approach should accrue to all areas and regulate cash flows. Also, auditors should keep an eye on decisions made by financial directors and consult with them on important matters. The underlying aim of the audit market is to assure investors and the public of the fairness of accounts and this sanctity should be maintained. Changing the accounting rules is only the beginning.
What else can accountants do
It is also important for the accounting firms to include their clients in the discussions and allow them space to share their thoughts too. This helps in building trust as shared below.
A better transparency, ethical accounting, and communication with customers can help get the faith back in outsourcing.
BY: AMIT AGARWAL
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