A rough ride for smoothers

Forget ironing out peaks and troughs - company accounts should tell it like it is. Roger Trapp reports

After a quiet few months, the Accounting Standards Board has suddenly bounced back into action. Commentators had barely had the opportunity to take in the full impact of the organisation's Statement of Principles for Financial Reporting when it last week published proposals for dealing with the contentious area of provisions.

In fact, it is quite appropriate that the two should have appeared at much the same time. This is because while the board's chairman, Sir David Tweedie, has said that the statement of principles is in effect the board's compass for navigating "uncharted waters in the years ahead", the latest document goes to the heart of his concern that company accounts should be transparent and easily understood by readers.

Provisions sound a good idea because they conjure up thoughts of prudent folks saving up in preparation for rainy days or unexpected events. The problem is that, in Sir David's view, such a sensible approach can easily be abused.

He is particularly keen to take on what has come to be known as the "big bath" approach, under which companies typically add together a bunch of reorganisation costs into a lump sum - often referred to in the accounts as an exceptional item. The difficulty for Sir David is that in recent years there have been so many changes in strategy in response to the tough economic environment that exceptionals have become - well, unexceptional. As he points out, companies such as British Gas and GrandMet record provisions in their accounts year after year.

Under the proposals, provisions for future operating losses would not be allowed at all and those for reorganisation and environmental costs would be permitted only once the company had an obligation to meet them - that is, cannot change its mind. Additionally, the board is looking for detailed disclosure of what the costs amount to.

This is a marked departure from present practice, which allows "management of earnings". This enables provisions to be recognised when a company intends to make expenditures as well as when it is obliged to do so. Allowing intent to be the basis provides executives with scope to manipulate the amount and timing of the provision. Combining this with the big bath approach, which can sometimes take in several future years' expenditure, creates confusion for the reader, say Sir David and his colleagues.

In keeping with their policy in the five years since the board was set up to be a stronger bulwark than the Accounting Standards Committee against the more imaginative forms of financial engineering, they see the suggested approach as providing greater transparency. Instead of seeing a big figure in one year and nothing for a few succeeding ones, or even several years of large, undetailed lump sums, the reader will be better able to see the link between the provisions and the relevant financial period, says the ASB.

The result of this, of course, would be volatility of profits. Sir David does not see a problem with this if it shows the true picture. But he accepts that the fluctuations are the "stuff that management feels uncomfortable about".

Such an approach is, however, anathema to those accountants who have come to be known as "matchers" or "smoothers" because of their keenness on ironing out the peaks and troughs in profits in the interests of showing steady progress.

Among the leading lights in this group are the Big Six firm Ernst & Young, which, with clients such as Hanson and BTR, can expect to have had some experience in accounting for reorganisations. Ron Paterson, the firm's technical chief, was recently quoted as disputing Sir David's view that the ASB approach amounts to "telling it like it is". Rather, it is "an academic diversion based on an economic theory which sounds good in the abstract but is not practical", he is reported to have said.

While the ASB concentrates on assets and liabilities in the balance sheet, he suggests looking at transactions and their allocation between accounting periods. That, of course, leads back to the concepts of accruals, matching and prudence that Sir David is so suspicious of. But Mr Paterson does not believe the risk of abuse means that the system should be abandoned; it should just be regulated, he says.

It is a view that seems to be in accord with the thinking of Gerry Acher, the head of audit at KPMG. While welcoming the ASB discussion paper on provisioning, he says there is a risk of catching other targets while aiming for the big bath.

"Genuine restructurings are largely driven by a need to sort out a company's inheritance from its past, and provision can often be appropriate at an earlier stage than a strict commitment basis of accounting might permit," he adds.

Sir David's view is that his approach to provisions in general is a natural follow-on to the treatment in earlier standards, tightening up the rules relating to discontinued operations or acquisitions, and will also fit neatly with proposals due in the new year for dealing with the accounting of assets. Furthermore, he points out that his beliefs accord with international thinking, as shown in a recently published paper from leading overseas accounting standards setters.

That will not stop the smoothers from arguing their case. As many commentators point out, this is becoming increasingly complicated stuff. But that does not mean that large chunks of the financial community will not be battling with each other in the months leading up to the end of the consultation period in March.

After all, as Mr Acher says, in asking for a re-examination of "our notions of prudence and of a liability", the ASB could be changing accounting as we know it.