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Why is it so hard to get reliable data from accounts?

Richard Murphy argues that the current state of accounting means that much of the data accountants produce is of no use to anyone. If this is the case, then surely the very status of the profession is under threat? And what can be done about this?

13th Dec 2019
Founder and blogger Tax Research UK
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Square Peg in a Round Hole
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I was in discussion with a reasonably heavyweight fund manager recently. He was bemoaning the state of accounting. His complaint came in three parts. The first was that accounting was unreliable. The second was that it was inconsistent. And the third was that it was hard to identify when this mattered. I admit that I probably assisted him to reach these conclusions: all are opinions I have held for a long time. Let me explain.

First, accounting is unreliable because current accounting standards provide too many occasions when costs may be deferred. Revenues may be brought forward, revenue costs can be capitalised and capital costs can be written off to create a distorted view of revenue generation over time.

All of these are essentially because the idea of prudence has long since departed the accounting profession. With it went the willingness to use an adequate ‘true and fair over-ride’ on the part of auditors. The result is data that cannot be relied upon to be true and fair any more. That means it is unreliable.

Second, accounting presentation is inconsistent. Although there is not an accountant who does not know what shape a profit and loss account, cash flow, balance sheet and notes to the accounts (I use the terminology deliberately because these terms have meanings that their replacements do not) should take when it comes down to published data the variations in presentation are far too great. And this matters.

In an era when technology should make the interpretation of accounting information easier and not harder that’s not happening precisely because, as anyone who tries to do this in-depth knows, translating company accounts into a database format is exceptionally hard once you move beyond the headline figures.

The loss of research funds as a result of the MiFID II rules on charging for investment research have only exacerbated this problem: the money to transcribe accounting data to permit its analysis simply does not exist anymore.

The result is that it’s getting ever harder to spot accounting irregularities. And when more and more cash is invested through tracker funds no one seems to have the incentive to look.

This matters for the integrity of financial markets. The primary purpose of accounting data, according to the International Financial Reporting Standards Foundation, is to assist those engaging in buy and sell decisions in those markets.

Right now though, I agree with the fund manager mentioned at the start of this piece: accountancy is failing miserably in this regard. But it’s even more important than that. If the data we produce is of no use to anyone the status of our profession is under threat. And that, I think, is precisely where we’re headed.

And it’s not just in the financial markets that this matters. Whilst I spend most of my time on research these days, I still do client-facing work. I was trying to do a quick appraisal of a company I’d been asked to look at recently. The problem was finding readily accessible comparatives to establish a benchmark industry norm to determine whether the data I was looking at was reasonable or not. This was hard, and overly costly, simply because every set of accounts I looked at seemed to make it as hard as possible to secure the data in a reliable form for comparison. So this is a problem all accountants can face.

However, it’s not my style to moan without suggesting a solution to the problem I’m looking at. And in this case, the solution is quite straightforward. Given the advances we have seen in IT, accounting standards and company law, I think it is entirely possible that all accounts could be subject to a standard coding framework to ensure that the data in them can be automatically uploaded to standard, and I would hope free-to-access, databases that will permit easy interpretation of data.

What sort of data interpretation? Simple stuff would do for starters. Debtor day ratios. Stock turnover ratios. Creditor days. Productivity data like turnover to assets, and employee cost and headcount. This stuff is not rocket science. And if we could also do some decent tax analysis at the same time, plus some comparison of group and parent company accounts, much of the information needed to spot accounting crises coming would be readily available to all users of accounts.

Downscale it to the sorts of accounting software most of us use and we could deliver pretty standard added-value products for clients at limited cost to help them make that most useful of things, called profit.

That’s what this profession should be about. Why is it being made so hard to do?

Replies (18)

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By Tony1958
13th Dec 2019 10:18

Well I'll probably get shot down in flames here as I am not an accountant, nor a book keeper. I am a lowly engineer.

It has always amazed me how useless the standard format of statutory accounts is. We have one line for the most important item in most businesses, the cost of sales, with no detail. Then we have a schedule detailing a load of nothing costs, like how much we spent on paper for the photocopying machine. It's been like this for years and is the same in every business large or small.

Perhaps one of you guys who is much wiser than me can explain why?

Cheers

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Replying to Tony1958:
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By Tom 7000
13th Dec 2019 10:24

Because you didnt ask your accountant to do it differently and he just pops the figures from the bookkeeping in the computer programme that makes company accounts and is only worried about getting the Tax right so he doesn't get sued

You get what you ask for :)

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Replying to Tony1958:
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By meadowsaw227
13th Dec 2019 10:27

If they are statutory accounts, who cares.
If they are for managing the business you would have a different format that could/would go into the enth details of the "cost of sales" and anything else that you would need to know.

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By meadowsaw227
13th Dec 2019 10:23

A professor and a chartered accountant - says it all !

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By ShaunSpalding
13th Dec 2019 10:54

Wasn't this also the early promise of iXRBL that it would be extended to give researchers and investors "instant" comparability across performance indicators such as those quoted in the article? In these days of constant "AI" and "Big data" buzzwords, am surprised that we do not hear more about this?

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By dmmarler
13th Dec 2019 11:00

You are only looking at the statutory accounts, but the information you seek is in the management accounts which are private to the business. The stat accounts are almost a complete waste of time and can only really provide headline data. International Financial Reporting standards which effectively govern the format of the stat accounts are designed by accountants in audit so are governed by that perspective, and not by management accounting.

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By Meltonmark
13th Dec 2019 11:49

Seems to me, the first objective of any organism is survival. After that comes self-development. Accountants secured their survival via legal requirements but had no way to develop their profits. Enter the plethora of accounting bodies, regulatory commissions, Standards Authorities, etc. I really don't know if 45-years after I started with ICWA, the accounting profession has actually improved anything other than their 'thank God I'm here' approach. I have sat in inumerable EXCOs, MANCOs, BMs, AGMs, etc and to this day, still hear the same complaint; "What does it actually mean though?" or words to that effect. The accounting profession has become master of complicating simple things, just because it can, to try and bamboozle clients into believing accountants must be ever such clever people. Personally, I would like to see CASH accounting taking precedence over the convoluted nightmare we have today. Most of my clients [I am semi-retired and have non-Corporate clients now] want to know their cash 'profit' position, meaning, are they 'making money'. Are they cash-positive in both this period and in the foreseeable future. They have no interest in my spouting on about complicated 'accounting things'. They had £X at the start of the year. They now have £x+/- at the end. Seems like a good/bad year. What do I think/suggest?

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By johnjenkins
13th Dec 2019 12:56

That's because there aren't many Accountants about. Plenty of number crunchers purporting to be Accountants.
An Accountant will go through the accounts with the client so they are well aware of what it all means. This could give rise to further investigations or discussions.

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By adam.arca
14th Dec 2019 09:09

To a certain extent and as contradictory as it sounds, I agree with Richard Murphy and I also agree with the comments made on his article. Accountancy is in a mess as a profession.

Back in the 80s when I studied accountancy at university, we were told then that there was a conflict between the stewardship role of accounts to report to the business owners and the information role to assist investor support to make decisions. I don't think anything has changed since then and the legal duty upon directors related to accounts is still to fulfill that stewardship function and not to support investment decisions. If, as Richard says, the standards people are saying the primary purpose of accounting data is to support investment decisions, then frankly they are whistling in the wind as that can only ever be an add-on within the current legal framework.

Richard moans about the departure of prudence and that there are still too many opportunities to smooth profit. I think that's a case of trying to have it both ways as prudence left this life as a fundamental accounting concept under the influence of David Tweedie and his pie in the sky "conceptual framework" for accounting standards in the early 2000s. And what was Tweedie but a trumpeteer for accounts as investment devices?

I do agree that the quality of accountants today has fallen and that has arisen from the rise of US-style prescriptive rules-based standards and the decline of accounting judgement (so, two sides of the same coin). Whether that can be extended to an argument that there ought to be some standardised rules on what can be recognised when in the P&L I am less sure as, personally, I have never been convinced that you can have universal comparability across companies: for me, what is right for one company isn't necessarily right for another. It is (or should be) about judgement.

And for that reason, I have always hated the idea of a standard coding list which is one of Richard's proposals and has reared its ugly head from time to time in the past too. It is telling that the comment supporting this idea came from an engineer, yet the disciplines of accountancy (an art) and of engineering (a science) have very little crossover IMO.

One of the other comments made was that accountants today are drones and don't talk to their clients enough about accounts, thereby educating clients about the value of tracking their numbers. I agree. But I also think the profession has been forced down that route by the market place and price competition, also by the rise of apparently binary decisions from the standards and by the loss of independence of attitude. The loss of universal audit as a function of our role probably has a lot to do with this latter problem too.

I would fundamentally disagree that cash accounting is the way to go as no half decent-sized business can possibly have a full handle on where they are without accruals accounting. I am sure the engineer will agree that, whilst simple is usually better, it isn't the answer when it only does half the job!

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By johnhemming
14th Dec 2019 13:32

Investors (such as myself) look at the values for free cash flow. Things like depreciation will always have some uncertainty. I not sure there is anything much that can be done on the question of accrual beyond which is already being done.

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Chris M
By mr. mischief
15th Dec 2019 19:36

As a successful investor over the last 25 years, I use the following approach:

1. Can this company fiddle the cash? Mostly the answer here is No, but always be aware that the likes of Polly Peck went bust with massive "cash" balances held in Turkish Cyprus so totally unable to plug the holes in the balance sheet in the UK.

2. Look at the cash flow statement.

3. If you are reading the whole annual report, start at the back. That's where the dead are most likely to be buried.

4. From the cash flow, and from reading back to front, build up the 3 or 4 main questions you want the board to have answers to.

5. At the front, see if they have bothered to answer them. Worse still, see if the main reports of the Chairman and MD attempt to misdirect the reader away from those issues. If they have answered them with honesty and credibly, that is a really good sign because it is also quite unusual.

Xero is a company we're all familar with. In my view - see previous posts - it's board leaves all the important issues totally unanswered and attempts to direct the reader away from the most important concerns any sesnible investor should have. Totally non-investible using the 5 criteria above.

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By edhy
16th Dec 2019 08:55

Forecasting (for Capital Market) is but one of the uses of Accounting e.g. another important use is Accountability of assets / resources.
For the profession true and fair view still overrides but there are individual follies by accountants and auditors, I must admit there are quite a few, we should know that failures are highlighted like air plane crashes.
If a rigid reporting structure is prescribed it will distort true and fair view as every business is "unique".
XBRL had great potential and still has along with better utilization of other ICT tools.
No one suggest abolishing Police force due to their failures. What profession needs to address these issues is more oversight and regulation but not more standards.

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Hallerud at Easter
By DJKL
16th Dec 2019 13:07

The catch with all of this is that in the world of business the "invention" of financial products, the growth in complexity of international aspects etc have, over the years, grown more and more significant.

Because of this, and arising from issues and scandals (knee jerk),the profession has considered it has to move to a far more rules based approach. But with this there is a catch, the catch being that if I can slot something into my accounts that is not stopped by said rules, it must be okay, so we now have accounting and business organisations engineered to fit within such loopholes.

And we place pressure on quoted companies to perform these tricks and the "devices" used then trickle down the food chain.

Frankly I blame the investors and the analysts more than the companies, we demand EPS growth, we view cash held as suppressing ROCE and punish those boards who dare to retain cash, certainly in the UK we demand higher dividends and only mildly admonish a company borrowing to have the cash to pay the dividends, and heaven help the dividend cutter- we seem to prefer they all keep on borrowing rather than doing their financial good housekeeping. And what about the incentives we pay those running the companies, geared to the EPS and share price and we then need to ask "where did reporting go wrong", doh, it went wrong because he gets paid depending on how these look, we look at performance motivation but somewhat treat stewardship and probity as the ugly sisters,

Sort out how Directors are remunerated and a lot of the reporting issues will then get resolved, they need the motivation to change so we need to remove the significance of share price/performance from the package,anything else is just fiddling whilst Rome burns, more rules, they will be circumvented, True and Fair, we have a wild west out there and thinking it will be controlled by T & F is like saying fight by the Marquis of Queensbury rules down an alley in Glasgow, it ain't going to happen.

Greg Lake , somewhat adjusted, says it all , "The Accounts we get we deserve"

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Chris M
By mr. mischief
16th Dec 2019 16:33

We need far greater penalties for dodgy directors and dodgy auditors. In the wake of the Enron scandal, there was a noticeable move in some companies to shore up balance sheets properly and, if necessary, take the hit on share price cuts. No-one wanted to be the next Enron or Arthur Andersen.

Now a new generation of company directors and auditors is around who see accounting and balance sheet trickery as a one-way bet in their favour. Make that one-way bet a 2-way bet by massive fines and a few prison stretches and the behaviours will change.

The auditing profession is a chocolate fireguard. The institutes will let a Big 4 partner sign off any old drivel with zero risk of disciplinary action, but the small beer guy is right in the firing line for relatively minor misdemeanors.

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By johnt27
16th Dec 2019 17:10

Somebody clearly didn't spend enough time on Google - a quick search provides any number of credit reference and benchmarking tools available - some at reasonable cost, others not. Better still, I can benchmark my clients along with all the other things the author wants at relatively little cost, but huge value to my clients, with the cloud tools available to me in the market. There are plenty of excellent firms in the UK serving their own particular niche sector in this way.

Yes, this could be done better (and for free) with the XBRL project that's been subject to political delay/ignorance and was pushed back again this year. In addition for small/micro companies, with current exemptions, you only get part of the picture and political decisions would need to made as to how/if this restricted data where to be made available and to whom. It's all doable now, just not implemented in law or the relevant software.

As for comparability, well accounting standards are open to interpretation, for good reason (in most cases) and it's down to the preparer of the accounts to explain, appropriately, how these have been applied. Ironically, big quoted firms are generally pretty good at this with the FRC and markets taking a hawkish view on disclosures and their quality. Unfortunately, this diminishes rapidly once you drop to SME world with boiler plate text generated by AP software. The impending MTD regs, along with the application of machine learning at pre-accounting level, will tighten things up in future years in terms of consistency.

Let's not rely on computers to do our interpretation for us but actually apply our minds to the problem - that might solve the heavyweight fund manager's computer says no problem.

What's with the lousy terminology used in this article? Costs are accrued or prepaid, not deferred - that's for income. which can also be accrued... And prudence may have been absent for a few years but she's back with a bang thanks to IFRS 9.

This article, and the previous one, written by this author explains a lot about why we have to spend a considerable amount of time with our graduate trainees going through a period of un-learning...

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Replying to johnt27:
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By Tony1958
17th Dec 2019 10:06

Many thanks to everyone that has replied to my comments. I appreciated the time that you have all taken and given views from a number of different standpoints which I had not considered.

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By ShayaG
18th Dec 2019 15:32

I think the fundamental premise of accounting and indeed of double entry book-keeping - that there is an objective and universal definition of profit - is quite an exuberant one. There will always be judgment areas on foreign currency, recoverability, revenue and costs recognition. Business affairs are complex and varied, and it is rather difficult to capture, for example, the value of an investment property.

Human nature will always, on average, push directors to make asocial decisions which favour them personally if presented with an option to do so.

Still, I remain of the view that something is better than nothing, and that a world with accounting is better ordered than a world where we made no effort at all. I am sceptical that increased regulation, more prescriptive rules, less prescriptive rules, and increased liabilities to directors personally will make much material difference. There never was a golden age.

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