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What's so hard about keeping accounts simple?

Sun, 15th Apr 2007

BY TURNING ITS 2007 annual report into a 454-page, 1.5kg WMD for the postal system, HSBC may have been hoping to bring down the current reporting regime at a stroke. Yet while there is widespread agreement that present rules leave much to be desired, reducing the reporting story to the need to slash overweening bureaucracy is disingenuous to say the least.

It is certainly true that regulation has increased, is increasing and, in some areas, probably ought to be diminished. The HSBC report contains 133 pages of notes explaining how the figures are affected by the application of the International Financial Reporting Standards (don't ask), which came into force in 2005. Some senior executives complain that IFRS makes many company results harder, not easier, to understand.

But it is worth asking how we arrived at this unsatisfactory position. The background is that for a supposedly 'hard' discipline, accounting is actually surprisingly 'soft', a matter of opinion as much as fact (one measure of the fuzziness of today's accounts is its failure to illuminate the often enormous gap between balance-sheet values and what a com pany is actually worth, tellingly ascribed to 'intangibles'). As a result, one longer-term trend has been an attempt to make the numbers paint a better picture by adding more and more of them.

The desire for ever greater quantification has been evident in all areas of management, even in non-financial areas. For at least half a century, managers and management academics have conspired to play down judgment and play up numbers as the basis for decision-making - managers with the aim of making management 'easier', and academics to render the discipline more 'scientific'.

Management can't somehow be made simple or scientific - it was WE Deming, a statistician (although strangely ignored in the mainstream management literature), who observed that the most important costs in business are unknown and unknowable. Some senior managers now lament that their juniors are so addicted to numerical targets that they can't work without them – their ability to make anything more than the simplest judgments has almost disappeared.

The tendency for detail to proliferate has been abetted by another enduring trend: the aggressively rules-based approach to accounting of many US firms, which takes the view that anything that isn't specifically forbidden is allowed. The result is a constant testing of the boundaries of the permissible, and a minuet with regulators in which every accounting innovation is greeted with a new regulation to block the loophole. Sometimes the boundary-pushing becomes so fierce that legislators are provoked into drastic action, as at the end of the last decade with the excesses of Wall Street, Enron et al. The resulting Sarbanes-Oxley Act is a monster that, while not addressing reporting as such, has become a monument to the box-ticking and compliance approach which now dominates many annual reports.

There is a third reason why authorities have found the urge to tinker with reporting rules irresistible: for all their length, most reports are amazingly uninformative. Yet none of the specifications makes it impossible to paint a true, fair and even entertaining picture of a company's performance.

Take Berkshire Hathaway, a large conglomerate with widely spread interests and revenues of $99bn. Its annual reports consists of 82 pages all told. It contains a letter from the chairman and CEO, Warren Buffett, which is not only a model of clarity about the company's situation, warts and all it is also a great read, studded with one-liners, anecdotes and nuggets of real wisdom about investment and management in general.

Companies may be right that reporting rules are confusing, and that regulation has reached the point where the preoccupation with preventing miscreants from getting away with bad stuff is making it disproportionately difficult for the good guys to do their legitimate job. But for all the above reasons - bad maths, bad behaviour and bad English - they deserve limited sympathy: they have largely brought the rules and regulations they complain of on themselves. As long as they continue to behave as in the past, testing the edges of legality, and sometimes crossing it, they are unlikely to persuade either legislators or the public to get off their backs. The remedy is therefore in their own hands.

No one reading Berkshire's report could fail to understand the nature of the business, the principles on which it is run, the mistakes it has made in the past, the influences on its present and future performance, and, not least, the character of those who run it. If more companies could show they understood their business so well, they would remove much of the pressure for ever more detail - as well as making the postman's lot a happier one.

The Observer, 15 April 2007


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