Accounting Bits

Financialized accounts: Restructuring and return on capital employed in the S&P 500

In “The Modern Corporation and Private Property” (1932) Bearle and Means observed how, over the period 1880–1930, US owner-managed corporate capital had become increasingly concentrated. Corporate growth had generated a need for substantial additional external financing making it increasingly difficult for owners to retain their majority stockholdings and the ownership of share capital becomes increasingly dispersed. In these circumstances stockholders retain beneficial ownership which includes the right to dividends and capital gains from selling shares in a second hand market but delegate control to a cadré of professional managers thus separating ownership from control. This divorce raised concerns about the principal–agent relationship between investors and managers when the motivations of managers may not coincide with those of stockholders, for example, managers may prefer to retain cash and profit for expansion at the expense of dividend distribution. In effect managers become less accountable to stockholders and Bearle and Means cite that by 1929, out of the top 200 US non-financial corporations, 44% of managers had stockholding interests of less than 20% a level which Bearle and Means deemed to be a controlling interest.

When share ownership is dispersed management is able to assume strategic corporate control employing appropriate organization structures to manage strategy (Chandler, 1962). The decision, for example, whether to outsource or internalise production acknowledges a positive role for management (Chandler, 1977). As such management strategy texts are concerned with how management moves can transform corporate fortunes and sustain competitive advantage (see, for example, Drucker, 1954 and Porter, 1985; Prahalad & Hamel, 1990). Stockhammer observes that a central feature of managerial capitalism of the post war period has been the relative autonomy of management but that:

A key feature of the post-war period has been that individual stockholders progressively ceded responsibility for managing their share capital and this, coupled with the growth in occupational pension schemes, has led to a pooling of assets under management. Investment banks such as JP Morgan Chase, Merrill Lynch and Goldman Sachs manage large blocks of corporate share capital, for example, JP Morgan Chase manages over $1 trillion dollars of equity funds (see Annual Report, 2005). Asset management is concentrated in a few large companies and their fund managers are paid generous bonuses if their portfolios perform well. This is an industry which is dependent on raising fee income which is calculated as a percentage of the aggregate MV of funds under management (FUM). In a highly competitive market where fee structures have eroded (McKinsey, 2003) there is additional pressure on the corporate sector to increase return on capital which, it is generally argued, will strengthen share prices and aggregate MV of FUM.

Financial incentives and the threat of corporate takeover focus managerial attention on the objective of increasing return on capital employed (ROCE) for shareholder value (SV). Rather than rely solely on managerial competence(s) what is required are mechanisms, monitoring systems and incentives around the metrics of SV that serve to align management behaviour with investor interests. Managers are encouraged to deliver SV and are paid bonuses or are allocated share options when they increase return on investor capital (see Fama & Jensen, 1983; Jensen & Meckling, 1976). If managers do not secure increased return on capital for investors there is an active market for corporate control that will discipline poorly performing management (Jensen, 1986 and Manne, 1965).

During the 1990s consulting companies played an important function advising companies on how to wrap SV performance metrics into corporate governance and executive remuneration packages (Boston Consulting Group, 1994; Stern Stuart EVA™, Holt Associates and CFROI). According to Froud, Johal and Williams (2002) strategy is financialized because management behaviour is consistent with the interests of shareholders and this is made possible because:

“On the side of investors, the necessary conditions are large scale investment in equities and bonds, traded in liquid markets which allow value investors (whether householders or professional fund managers) to exercise choice on the basis of performance as reflected (and constructed) in financial accounting data”

“From the corporate side, managers must have the power to exercise choice over patterns of merger, acquisition and organizational restructuring in an attempt to meet shareholder requirements; and finally there must be the development of senior management compensation schemes and career hierarchies which reward managers who pursue the interests of shareholders (which may not fully coincide with their own)”

In a productionist generic model of capitalism the capital market functions as unproblematic intermediary between firms requiring funds for investment and households a return on their savings. An alternative financialized model of capitalism suggests that financial intermediaries become regulators of firm behaviour (Froud, Johal et al., 2002). The priorities of managerial strategy are increasingly financialized resulting in “the engagement of non-financial businesses in financial markets” (Stockhammer, 2004) with possible negative consequences for investment and growth because strategy shifts from ‘retain and invest’ to ‘downsize and distribute (Lazonic & O’Sullivan, 2000).

In this paper we are concerned with how financialized accounts can be constructed to reveal a shift in the spectra of corporate financial calculation towards transactions that square the interests of investors and managers. Specifically how this might be “accounted” for at a meso-level; that is, for all firms in the S&P 500 and at a micro level within individual firms. Shareholder value is concerned with return on capital employed (ROCE) because both the numerator (profit) and denominator (capital employed) figure in shareholder value metrics. We start by describing the accounting framework employed in this paper and its purpose which is to reveal the financial elements that contribute to the bottom line ROCE. This account deconstructs the ROCE to reveal how financial diffusion and trade off’s impact on the bottom line ROCE.

In the second section of the paper we apply this framework to deconstruct ROCE performance of S&P 500 constituent firms and S&P 500 survivor firms over the period 1980–2003. Managers of S&P 500 companies have been relatively successful in delivering cost reduction and boosting cash residuals but this did not translate into higher ROCE. After a period active corporate restructuring during the 1990s we find that average ROCE remains untransformed because the value of capital employed inflates relative to earnings acting to put a brake on the ROCE. Our account also reveals a recent step-wise increase in capital employed in the balance sheets of the S&P 500 coincident with a change in way US firms account for business combinations.

The Financial Accounting Standards Board (FASB) Summary Statement No. 141 now instructs US firms to employ one approach the “purchase method” when they account for business combinations. This approach requires that US firms consolidate the market value of any “purchase” made into their balance sheets. Significantly FASB mandated changes are deployed to improve the efficiency of capital market allocations and reflect investor interests. US firms cannot now avoid absorbing the market value of business combinations into their balance sheets at a time when, we argue, it has become expensive to purchase another companies earnings. This change in the way US firms now account for business combinations presents an opportunity to construct financialized accounts. Specifically where the purchase cost of the deal significantly inflates the acquiring company’s balance sheet and the price to earnings (P/E) ratio of the purchased company is also relatively high.

In the final section of this paper we employ two cases: Pfizer’s recent acquisition of Pharmacia and Procter and Gamble’s purchase of Gillette to describe the accounting associated with the purchase method. They also demonstrate the consequences of consolidating a large additional lump of MV into corporate balance sheets when deals are expensive and P/E ratios relatively high. When each deal is completed balance sheet capitalization runs ahead of earnings reducing ROCE and forcing a financialized ratchet which activates further waves of cost cutting in combination with significant realignment of balance sheet capitalization. Cost reduction is needed to boost cash which, in turn, is needed to underwrite the financing charges associated with balance sheet restructuring. Of particular importance, in Pfizer and P&G, are share buy-backs which are accounted for as a reduction in shareholder funds, and thus capital employed, helping to improve post acquisition ROCE. Share buy-backs also distribute cash to shareholders and provide treasury stock which is used to reward managers who deliver cost reduction and shareholder value.

Tags: Capital employed

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Capacity to Treat Private Sector Nhs Plan

In the forward to the White Paper “The NHS Plan: A Plan for investment, a plan for reform” Tony Blair set out New Labour’s project of modernising the NHS in England through a combination of investment and reform. After a period of sustained underinvestment in health services the NHS Plan detailed how additional funding would expand hospital resources. Funding provided by the government to the NHS was set to increase in real terms by 7% per annum over a 5-year planning period. This commitment, it was argued, would reduce uncertainty and facilitate medium term planning in the NHS. Any extra funds would also be coupled to reform(s) to ensure that finance converted into additional hospital productivity and capacity to treat patients.

In the forward to The NHS Plan, the Prime Minister outlined the governments’ financial commitment to the NHS.

“So urgent was the need for extra money for the NHS that many of the failures of the system were masked or considered secondary. In March we took a profound decision as a Government. We had sorted out public finances. Debt repayments were down. Spending on unemployment benefits and other benefits associated with large numbers of people economically inactive, was down also. We decided to make an historic commitment to a sustained increase in NHS spending. Over five years it amounts to an increase of a third in real terms. Over time we aim to bring it up to the EU average.”

Arguments about the lack of resources in the NHS recede relative to those concerned with modernisation, managerial reform, delivering capacity to treat patients and extending patient choice. In the NHS Plan, it is made clear that if the acute hospital sector is to deliver additional capacity to treat patients it not only requires additional funding but this funding should be tied to reform.

“with the funding issue settled for the next few years, the NHS can address the need to reform itself – from top to toe – to meet the challenges of rising patient expectations.”

The NHS Plan clearly links investment with reform. Without reform, it is argued, additional investment will not necessarily translate into additional capacity to treat patients. This connection between investment, reform and capacity is elaborated through a series of illustrations in the NHS Plan. For example, investment in wages and salaries is associated with modifications to employee relations and working practises that in turn will be expected to increase NHS productivity and thus drive up capacity to treat patients. Working in partnership with the private sector would help to financially underwrite new capital projects that would also expand and modernise physical capacity.

Given the importance of labour, in what is essentially a service driven activity, the NHS Plan attached great importance to the reform of working practises in particular securing additional labour flexibility to improve patient care and increase available hospital capacity. Even before the NHS Plan the Labour government had anticipated that investing in a growth in staff numbers, flexible working, system and role re-design, higher retention and changes to pay structures would enhance patient care and more critically improve productivity and hospital capacity.

In return the government was prepared to invest in pay. “We are prepared to invest in pay. We also know the current NHS pay system inhibits the modernisation of the service. It has failed to keep pace with changes in NHS practice, and does not recognise that modern forms of healthcare rely on flexible teams of staff working across traditional skill boundaries”.

The NHS Plan also envisaged a major investment in buildings and infrastructure using a mixture of “public capital and an extended role for the Private Finance Initiative (PFI)”. On the capital-side of the resource equation, reform involved modifying the relationship with the private sector to secure privately financed contracts to design and build and possibly also deliver facilities management services to the NHS.

“Additional capacity for healthcare provision would also be secured by changing the relationship with the private sector in particular seeking PFI funding to build new hospitals.”

Using the private sector to underwrite the cost of capital projects in the NHS was attractive at a macro-accounting level because large lumpy capital commitments could be converted into a series of future amortised annual payments. Capital costs would be spread into the future appearing as expenditure in the accounts of individual hospitals. At a micro level value for money (VFM) capital project appraisal could be employed to financially justify the award of capital projects between private or public contractors. The accounting calculations employed in VFM have been subject to some criticism. In particular, that the accounting logics employed to allocate risk, cost and income between public and private sector contractor are faulty and more specifically that the financial benefits of using the private sector are small and uncertain. Grimsey and Lewis, 2002 and Grimsey and Lewis, 2005 observe that there has been little engagement between practitioners and academics on these issues. They argue a positive case for public private partnership (PPP) illustrating how governments can construct variably defined contracts to secure a range of transactional and agency relations with the private sector whereby market based contracts can be used to install incentives and discipline to increase efficiency.

A common concern in both the academic and practitioner critiques is with the assumptions employed to construct the financial cost benefit appraisals which are then used to allocate public funds to PFI/PPP projects. These assumptions are often not clear cut because we do not possess full information about the past the present and future. If risk and uncertainty cannot be eliminated then this opens up the possibility of a less than a straightforward connection between policy intention(s) and possible future outcome(s). A significant number of PFI and PPP contracts are now up and running in the NHS and the extent to which these projects succeed or fail to deliver VFM can only be assessed with an ex-post audit at a time when the contract with the private sector provider more or less completed.

A central objective of the NHS Plan was to reduce uncertainty. In providing healthcare managers with predictable future real increases in annual funding the government would significantly reduce financial uncertainty and secure medium term resource planning. The NHS Plan set out the government’s objective of increasing funding, in cash terms, by 50% a target increase achieved over the period 1998–2003. This additional real income to acute hospitals would, as we have already noted, be tied into capital and labour process reforms which were expected to combine constructively to resolve problems of chronic under capacity in the health care system. “The biggest problem facing the NHS remains shortages of capacity in staff and beds. The stability provided by the 2002 budget resources will allow the NHS and social services to plan increases in capacity with confidence”.

Tags: nhs plan

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The ethics of World Bank lending

The topics of corporate social responsibility and ethical investing have received increasing attention over the last two decades. Journals such as Accounting Forum, Accounting, Auditing and Accountability Journal and the Journal of Business Ethics have been at the forefront of this movement, publishing over 100 articles that deal explicitly with the topic of corporate social responsibility and/or ethical investing. This research has helped us to understand not only the dimensions of corporate social responsibility, but also the role that ethical investing can play in encouraging socially responsible behavior on the part of the corporations that receive such investment funds.

Initially, studies of corporate social responsibility focused on the types of corporations that provided such disclosures (Trotman and Bradley, 1981; Cowen, Ferreri, & Parker, 1987). This research was then supplemented by studies examining the market reactions to disclosure (Freedman & Stagliano, 1991; Patten, 1990, Patten, 1992a and Patten, 1992b), the linkages between social performance and social disclosures (Buhr, 1998; Herremans, Akathaporn, & McInnes, 1993), the influence of the external environment (Neu, Warsame, & Pedwell, 1998; Patten, 1992a and Patten, 1992b; Roberts, 1992) and the normative aspects of social responsibility (Gray, Owen, & Maunders, 1988; Gray, 2002). It is only recently that the social responsibility literature has ventured beyond the corporate world, attempting to understand the positioning of social responsibility within democratic processes (Lehman, 1999, Lehman, 2001 and Lehman, 2005) and within other organizations (Llewellyn, 1998 and O’Dwyer, 2005).

Despite this broadening of the social responsibility research agenda, we still know very little about the role that supranational organizations such as the World Bank play in encouraging social responsibility via their lending activities (for exceptions see Amba-Rao, 1993, Rahaman, 2004 and Szablowski, 2002). On the one hand, this lack of attention is not surprising given that the World Bank lends to governments rather than to corporations and that these loans are often targeted at social sectors such as education and health. But on the other hand, it is surprising. In the most recent fiscal period, the Bank lent $22 billion in support of 440 different projects. These monies, which often required matching monies from borrower governments, then flowed to private sector corporations in the form of contracts for goods and services. Furthermore, the loan conditions not only specified how the borrower governments could spend the monies but also how procurement, tendering and disbursement processes would operate. In these ways, the social responsibility vision and practices of the Bank directly and indirectly impact the conduct of business worldwide.

The current study examines the linkage among the social responsibility visions of the World Bank, the social responsibility requirements that are contained within Bank lending agreements, and what happens when these requirements are implemented. Our starting presumption is that this vision plus the resulting practices and ways of implementing Bank projects are key components of the ethics of World Bank lending. Our analysis consists of three parts, each adopting a different institutional level of analysis. First, we review the World Bank’s website and promotional material to infer the social responsibility vision of the Bank. We then concentrate on a subset of Bank lending agreements – in this case lending agreements pertaining to education in Latin America – to see how this social responsibility vision has been translated into a series of concrete lending requirements and accounting practices. Finally, we consider a single lending agreement and through the use of 40 indepth semi-structured interviews with participants we examine what happens when such requirements are implemented.

Our analysis highlights that the social responsibility vision of the Bank consists of two aspects. The “social” face focuses on eliminating poverty via building social and human capital, emphasizing participatory and “grassroots” approaches. In contrast, the “financial” face emphasizes the importance of efficiently using financial resources, the minimization of corruption and need for accountability. These two faces were present not only in the Bank’s social responsibility vision as contained in website materials but also within the lending agreements themselves. However, as the interview material highlights, the translation from abstract lending principles to concrete field practices is an uneven and uncertain process given both the tensions that exist between the social and financial faces of responsibility as well as the ways that the Bank chooses to implement and administer projects.

The current study contributes to our understanding of social responsibility in at least two ways. First, the study illustrates the importance of supranational organizations such as the World Bank in the diffusion of socially responsible practices. The types of projects that the Bank supports, the specifics of the lending agreements as well as the ways in which the projects are implemented and monitored directly impact on the borrower governments and indirectly impact on the corporations that provide the required goods and services. As a consequence, the potential of the Bank to encourage and facilitate certain types of social responsibility practices is enormous. At the same time, the study highlights the ambiguities of World Bank practices, for example, the difficulty associated with using truly participative approaches when designing projects, the ways in which the introduced financial and administrative systems encourage inefficiencies for the borrower country, and the tensions that exist between the social and financial faces of the Bank’s social responsibility vision.

2. The World Bank and its social responsibility vision

In terms of its history, the World Bank emerged near the end of the Second World War as part of a web of institutions whose purpose was to promote multi-lateral cooperation and international stability. Although the Bank was initially capitalized with nominal subscriptions from its member governments, the majority of its financing is raised through capital markets (Jones, 1992). Since its formation, the Bank has grown to include a series of three primary lending institutions: The International Bank for Reconstruction and Development was established in 1945, has had cumulative lending of $383 billion over this time period, and lent $11.2 billion during fiscal 2003 for 99 new projects in 37 countries; The International Development Association was established in 1960 to provide financing (including interest-free credits and grants) to the world’s 81 poorest countries, has had cumulative lending of $142 billion over this time period, and lent $7.3 billion during fiscal 2003 for 141 projects in 55 countries; and The International Finance Corporation was established in 1956 to promote economic development through the private sector, has had cumulative lending of $23.4 billion, and lent $3.9 billion during fiscal 2003 for 204 projects in 64 countries (World Bank, 2004). As these statistics highlight, the Bank provided more than $22 billion in loans in the most recent fiscal period, supporting over 440 new projects. Not surprisingly, given the magnitude of these statistics, the Bank is the primary provider of development assistance loans in the world. The Bank operates in “more than 100 developing countries” and has more than “some 10,000 development professionals from nearly every country in the world” working in its Washington, DC headquarters or in its 109 country offices.

Before turning to the Bank’s social responsibility visions, it is useful to briefly review what we mean by social responsibility. Although a myriad of different definitions exist, the majority of the definitions start from the recognition of interdependencies among humans and other things. As a result, humans – and their forms of social organization such as corporations – have obligations to current and future generations as well as to the other things that co-inhabit the planet. While the actual words used to define corporate social responsibility vary across individuals and organizations, the recognition of obligation forms the basis for defining responsibility. For example, the World Business Council for Sustainable Development defines corporate social responsibility as “the continuing commitment by business to behave ethically and contribute to economic development while improving the quality of life of the workforce and their families as well as of the local community and society at large” (WBCSD, 2005 WBCSD. (2005). Corporate social responsibility. http://www.wbcsd.org/templates/.WBCSD, 2005). Likewise the OECD states that:

Tags: Ethics lending

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The Code of Ethics and the development of the auditing profession in Greece, the period 1992–2002

In recent decades, a well-established body of literature dealing with Anglo-American accountancy1 has drawn attention to the “political” role of the profession showing that it primarily seeks to advance the sectional interests of the membership (Mitchell & Sikka, 1993; Mitchell, Puxty, Sikka, & Willmott, 1994; Preston, Cooper, Scarbrough, & Chilton, 1995;Sikka & Willmott, 1995). It has been maintained that the profession ceaselessly strives to legitimise its practices in order to attain and retain social privileges such as the monopoly of auditing practice and self-governance which “confer wealth and power upon the individual professional … and autonomy … upon the professional body” (Preston et al., 1995, p. 508). The success of its legitimation efforts depends upon the acceptance of claims to “credibility” and “ethos” by powerful institutional bodies “perhaps most importantly the state and its agencies …” (Preston et al., 1995, p. 510). To reinforce such claims and facilitate “trust” and confidence in its practices, the profession had introduced, refined and appealed to the efficiency of the disciplinary processes relating to the Code of Ethics seeking to build the image of a “credible” and “trustworthy” organisation. Thus, the Code is viewed as a legitimation device which plays a major role in assisting the Anglo-American profession in sustaining its privileged position within the economic context (Mitchell & Sikka, 1993; Mitchell et al., 1994 and Sikka and Willmott, 1995).

Though the literature has provided insights into the role of the Code and ethical arrangements in the advancement of the Anglo-American profession, little is known about their role in emerging contexts.2 Greece, for instance, is an interesting case to examine as, in the period 1992–2002, the self-governing auditing profession3 faced a difficulty in controlling the conduct of its membership and an increasing erosion of public confidence in its practices which was echoed in the press. Moreover, the profession’s jurisdiction was challenged by the intention of the state to set up an independent organ to supervise its practices and operation. Against this background, this paper examines how local professionals responded and whether they used their Code of Ethics and disciplinary processes to refine their image as a “credible” organisation. To achieve this, the paper draws upon the imperialism of influence framework to illustrate the political and economic influences that shaped the local settings within which the local profession operated. The paper is based on primary and secondary archival sources of the auditing profession, ministerial decisions and relevant Laws, academic publications, papers presented at conferences and the media. Furthermore, interviews were conducted with professionals who played an important role in the formulation and application of the 1997 Code of Ethics (see Appendix A for more details).

The remainder of this paper is organised into the following sections. The second section constructs the framework for understanding the role of ethical pronouncements in the development of the profession in an emerging economy. The third section provides a brief account of the political and economic context of Greece in the period 1992–2002, sketching the broader backdrop against which the profession was restructured according to the Anglo-American model. The fourth section draws attention to the challenges facing the profession and the strategies employed to respond to these difficulties. Moreover, it focuses upon the impact of the Enron episode upon the image of the local profession and the defensive tactics it adopted to re-establish its “credibility”. It is shown that the Greek Code of Ethics and disciplinary processes were employed by the profession to respond to public concerns and criticisms of its role and operation. The last section discusses certain aspects of the process of the Code’s formulation and sheds light upon its role as a legitimation device used by the local profession to maintain its position within the Greek context.

2. Understanding the role of the Code of Ethics in the advancement of the local accountancy profession

To understand the role of the Code of Ethics one has to be acquainted with views and notions found in the literature on the Anglo-American accountancy profession. The relevant literature could be divided into two broad branches. The first comprises conventional approaches which mostly rely upon professional proclamations and views regarding the professionalisation of accountants. The second is the critical branch which draws upon Weberian and Marxist theories to situate the analysis of the emergence and ascendancy of occupational groups in the broader social, political and economic context (for an analysis see Robson and Cooper, 1990, Saks, 1983 and Willmott, 1986).

Insights into the conventional approaches can be found in journals such as The Accountant and the Journal of Accountancy.4 Mostly written by professionals, articles published in The Accountant defined the Code of Ethics as a set of rules and principles designed to “rule out undesirable activities” (House, 1956, p. 367). These rules were aimed at prohibiting members from allowing commissions or brokerage, engaging in incompatible activities, certifying accounts not verified by them and soliciting clients or encroaching upon the work of other members. Other rules made explicit references to the public interest, integrity, objectivity and independence of the membership. Such rules outlined the broader context within which accountants had to exercise their activities (Cooper, 1907, Montgomery, 1907, Price, 1900b, Richardson, 1936 and Sterrett, 1907). Accountants argued that these sets of rules were distinctive elements of “professionalism”, which distinguished professions from other occupations (see also Carey, 1956 and Cooper, 1907). It was also maintained that accountants’ associations comprised a professional body and as “every profession worthy of the name evolved with its growth a kind of moral code” (Dicksee, 1909, p. 380; Price, 1900a, p. 922).

Tags: Auditing profession

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Listed Companies using National Accounting Standards

This paper explores sophisticated measures for assessing and comparing the success achieved in converging National Accounting Standards with internationally-prescribed sets of accounting standards (such as those comprising IFRS).

The development of sophisticated measures of convergence is important for two principal reasons. First, not all countries have committed to adopting IFRS. For example, Iceland, Japan and Saudi Arabia are reported by the International Forum on Accountancy Development [IFAD] (2003) to have not yet expressed an intention to converge with IFRS. Some other countries (e.g. New Zealand) have opted to converge with IFRS over a longer time period (by 2007). Indeed, IFAD (2004) has reported also that as at December 3, 2004, IFRS were ‘not permitted for domestic listed companies’ in 36 countries (including Argentina, Brazil, Canada, Chile, Fiji, India, Indonesia, Mexico, Philippines Taiwan, Tunisia, United States and Vietnam). Consequently, for such countries, there are likely to be information benefits in measuring and monitoring the extent to which National Accounting Standards approximate IFRS. There are also likely to be benefits for capital markets and other users of financial statements in helping to assess the quality and comparability of published accounting data in those countries.

Measurement of convergence is important also because, in some EU countries that have adopted IFRS in 2005, the application of IFRS does not extend to all entities, but is confined to listed companies. The accounting standards that are to apply to non-listed companies are being debated in such countries, and an important issue is whether IFRS will affect the accounts of non-listed companies. Street and Larson (2005, p.1) conclude that ‘most EU members do not plan to converge national GAAP with IFRS, thereby highlighting … concerns regarding the emergence of a “two-standard” system in the EU’. The main barriers to convergence identified by the survey are the link between financial accounting standards and tax accounting; and disagreements about the complicated nature of certain IFRS, especially those associated with ‘fair value’ accounting.

It seems to be taken for granted that IFRS are good for non-listed companies and that they should supersede National Accounting Standards. Perhaps this is because the official discourse of international accounting standardization is made by ‘the audit industry and its agents’ in such a way that ‘users tend to be represented rhetorically rather than physically’. Why has there been such a sudden rush to converge national GAAP with IFRS, even for non-listed companies? Is financial accounting ‘solely a functional reflection of the internationalization of financial markets, or are other factors at stake?’. How does accounting, as a technology and a social practice, serve to structure various institutional fields affected by globalization? Why is it that accounting technologies and accountants help to propagate organizational agendas, policies and purposes and, in doing so, amplify certain voices but do not ‘amplify others, yet these others deserve to be heard’.

In 2003, the Portuguese Accounting Standards Board (Comissão de Normalização Contabilística) proposed a dual accounting model for Portugal. This model required individual and consolidated accounts of listed companies to be prepared using IFRS. However, other entities have the discretion to use either Portuguese Accounting Standards (issued by the CNC) or IFRS. Thus, a dual regime of accounting standards would prevail: one for listed companies and the other for non-listed companies. In these circumstances, a measure of convergence will be invaluable in assessing the extent to which the accounting methods allowable for non-listed entities converge with the methods permitted under IFRS. Obstacles to convergence in Portugal include the tax driven nature of national accounting requirements, the complicated nature of certain IFRS and the legal basis of Portuguese GAAP. Non-listed and local companies, audited by local auditors, feel more comfortable using National Accounting Standards because these standards are more in tune with their code-law, economic, and social backgrounds.

It is important to examine and measure formal harmonisation carefully because of the increasing influence of accounting regulations on accounting practice. The first of three measures of convergence we analyse was outlined by Garrido, León, and Zorio, 2002. It was intended to assist in evaluating progress in converging any two sets of accounting standards, and is based on the concept of Euclidean distances. But we argue that measures based on Euclidean distances have serious shortcomings.

Accordingly, we propose more robust measures involving Jaccard’s [association] coefficients and Spearman’s [correlation] coefficients because they provide a much stronger foundation for evaluation and seem likely to benefit a wide range of users of published financial statements. For investors, they provide a compact yardstick for comparison of the quality and content of financial statements published by companies in a variety of countries and settings. They provide enhanced measures of confidence and reliability by showing the similarity and dissimilarity between the allowable accounting methods that underpin those reports, and the variety of accounting ordained in IFRS. For regulators, the measures we advocate can be disaggregated to reveal the areas of accounting (such as valuation or revenue recognition) that are most dissimilar from IFRS and for which reform should be a priority. We illustrate the strengths and weaknesses of the three measurement methods by calculating the performance of Portuguese Accounting Standards setters in achieving convergence with IAS and IFRS between 1977 and 2003. Our choice of Portugal is opportunistic. It is motivated by our in-depth knowledge of Portuguese Accounting Standards-setting issues, and by assertions that Portuguese Accounting Standards are converging rapidly with international standards.

We begin by briefly reviewing prior literature on the measurement of formal and material harmonisation; and delineate several recent phases in the evolution of IFRS and of National Accounting Standards in Portugal. Thereafter, we review the measure of convergence (based on Euclidean distances) that was outlined by Garrido et al. (2002), and highlight its shortcomings. We then propose Jaccard’s association coefficients, supplemented by Spearman’s correlation coefficients as better measures of the convergence of National Accounting Standards with IFRS.

The distinction between formal (de jure) harmonisation and material (de facto) harmonisation is important. Formal harmonisation refers to the way accounting standards are written: that is, to their legal or quasi-legal specification. Material harmonisation refers to the level of concordance exhibited by the actual practices of companies in implementing accounting standards. Several indices and measures have been developed to evaluate material harmonisation in accounting (for example, the H, C and I Indexes, the Total Comparability Index, the Within-country Comparability Index, the Disclosure-adjusted Index, the Adjusted “Between-country” Index, and Associations Coefficients.

Association coefficients have been used by D’Arcy (2001) to cluster national accounting systems in terms of financial reporting requirements. Jaccard’s coefficients have been used to measure accounting practice harmony by Rahman et al. (2002). However, until now, the majority of empirical studies of accounting harmonisation have focused on material harmonisation. As a consequence, the absence of literature on formal harmonisation measurement methods is unsurprising.

Tags: accounting standards

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‘Not our problem’: UK Government’s fiscal obligations towards the privatised railway network

Analysts of public finance are devoting increasing attention to what have been termed implicit fiscal obligations of government, those that are not recognised in public sector accounts or budgets, but are nonetheless real, in the sense that future resource commitments have been potentially incurred. For example, an aging population in many countries implies that future expenditures (on pensions, health care, etc.) will increase more rapidly than revenue, given current tax rates. In theory, the projected deficits could be reduced by reducing pension or health entitlements, but this may be politically difficult if not impossible. Heller (2003) has attempted to draw attention to this and other long-term fiscal implications and has urged that governments need to recognise these challenges in order to increase transparency of potential government commitments.

Implicit commitments may also take the form of guarantees by the state in respect of some private sector concerns, for example the underwriting of the debts of providers of public services. Such contingent liabilities are typically unrecognised in public sector National Accounts, but result in implicit obligations. Even if no legal guarantee exists, there may still be what the (US) General Accounting Office (2003, p. 3) defined as ‘implicit exposures’ which arise, not from ‘a legal obligation of … government but rather from implied commitments embedded in the government’s current policies or in the public’s expectation about the role of government’.

Determining the extent of a government’s implicit obligations may, as Heller noted, involve considerable ‘hazards and complexities’ but is an essential step ‘towards a more comprehensive picture of a government’s overall potential debt exposure’ (p. 64).

Organisations such as the International Monetary Fund (IMF) and the Organisation for Economic Co-operation and Development (OECD) have urged countries to reform their national accounting practices to ensure transparency in state budgeting and the disclosure of implicit as well as explicit liabilities, and some countries have taken steps in that direction1 (IMF, 2001a and IMF, 2001b; OECD, 2001).

Emphasis on more extensive disclosure of contingent liabilities was particularly evident in the IMFs Code of Good Practices on Fiscal Transparency (IMF, 2001b). The IMF calls for, inter alia, an assessment of contingent liabilities and for implicit debt to be identified and, if possible, quantified.

The OECD also supported the IMFs concern about contingent liabilities in governments’ financial policy commitments, and its Code on Budget Transparency (OECD, 2001) specifically highlighted policy commitments that might have a significant future financial impact and which should be taken into account in the formation of national budgets.

Overall, there is increasing recognition that failure to budget for fiscal obligations such as those represented by contingent liabilities ‘induces governments to take risks that may imbalance future budgets’, and that ‘it is absolutely crucial that the fiscal consequences of existing commitments be explicitly disclosed’ (Schick, 2002b, p. 19; Heller, 2003, p. 169).

One area where implicit government commitments may exist is in relation to the economic infrastructure, even where such infrastructure is privately owned (Irwin, Klein, Perry, & Thobani, 1999). Privatisation of infrastructure is typically justified as a means, inter alia, of transferring commercial risk and fiscal obligations from the state to the private sector but, in practice, this may be more apparent than real. Frequently, the debts of the private sector operator are underwritten by the government, but the contingent liabilities thus created are typically ignored in governmental National Accounts (Polackova, 1998). By their very nature, contingent liabilities may not be necessarily costless, and should be properly accounted for and valued (Mody & Patro, 1996). Even if no formal indemnity exists, governments may find it politically impossible to allow the failure of an infrastructure private operator (perhaps because the infrastructure in question is crucial to the functioning of the national economy). In practice, government may be compelled to rescue an operator that found itself in financial distress: there is a de facto guarantee and an implicit fiscal obligation. The promised divestment of risk may be illusory, and it has been argued that governments need to manage their exposure to such risks and value them properly in their accounts (Lewis & Mody, 1998; Brixi & Mody, 2002; Ehrhardt & Irwin, 2004).

This paper focuses on the UK Government’s management and reporting of its fiscal obligations in respect of the railway network, after the collapse of the privatised rail infrastructure company Railtrack in 2001, and now proceeds as follows: Section 2 outlines the events leading up the collapse of Railtrack and the impact on both the company’s investors and the government’s response; Section 3 details the structure of its successor body, Network Rail; Section 4 analyses the way in which the borrowings of Network Rail have been treated in the National Accounts; Section 5 contains a discussion and some conclusions.

2. The privatisation of the railways

In 1996, the then Conservative government commenced the privatisation process of the UK railway industry. The resulting arrangements were complex. The infrastructure (stations, track and signals) of the former state-owned British Rail was transferred to Railtrack plc and the equity issued to private sector investors: its revenue came from user fees (‘Track Access Charges’) mostly from the private sector train operating companies (‘TOCs’) who were awarded franchises (initially 25) to operate passenger services. To minimise abuse of its monopoly by Railtrack, the government set up the Office of the Rail Regulator (‘the Regulator’)2 to regulate Railtrack’s activities and to determine its return on capital. Train franchises were awarded, and the performance of franchisees monitored, by the Office of Passenger Rail Franchising (OPRAF). In 2000, the Labour government established the Strategic Rail Authority (SRA), which acquired the functions of OPRAF in an attempt to plan more effectively the strategic direction of the railway industry as a whole.3

Tags: Railway network

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GRI and the camouflaging of corporate unsustainability

Under the traditional businesses approach, ecological and social issues are ignored in management objectives because they are not visible or do not have a significant financial impact. After the Brundtland Report in 1987, sustainable development (SD) was a concept implemented by corporations and business organizations (e.g. CERES). Although some companies are considering embracing SD or sustainability1 at a strategic level, as they see clear synergies between value creation and attempts to contribute to SD, the evidence also points to a different reality where this issue “may be marginalized or moved off to agendas unrelated to the firms’ core business” (Dunphy, Griffiths, & Benn, 2003, p. 111).

Social and environmental accounting and reporting (SEAR) has been a relevant subject in the academic literature (Gray, Owen, & Adams, 1996). The Triple Bottom Line notion derived from the definition of the sustainable development in the Brundtland Report, has added economic development to SEAR (Elkington, 1999). Under this approach, known as Triple Bottom Line Reporting, the Global Reporting Initiative (GRI) sustainability reporting guidelines were first developed with the aim of assisting “reporting organisations and their stakeholders in articulating and understanding contributions of the reporting organisation to sustainable development” (GRI, 2002, introduction).

Preliminary evidence from practice seems to show that these guidelines are used in a biased way. Some organizations that label themselves as GRI reporters do not behave in a responsible way with respect to social equity (for example, health care companies in South Africa) or human rights (for example, some oil companies in developing countries).2

The evidence could be explained as a wrong interpretation (conscious or unconscious) of the concept of SD, or it could be argued that something is failing when transmitting the idea of sustainability from the guidelines. The concept of SD is reduced to simply giving basic information on the indicators that comprise the Triple Bottom Line (TBL), which unfailingly leads to a gap between corporate performance and corporate impacts. Thus, GRI guidelines could be considered as an administrative reform that it is insufficient to enable new accountability relationships (Larrinaga, Moneva, Llena, Carrasco, & Correa, 2002; Owen, Gray, & Bebbington, 1997).

The aim of this paper is to look at sustainability within the GRI guidelines and try to find out what is missing (if anything) in the GRI guidelines and consequently, what conception of SD is being constructed and diffused. The first guidelines were published in June 2000 as a pilot document for very few companies. After their analysis and a multi-stakeholder process, a second version was presented at the Johannesburg Summit (August 2002). Many things have changed between the first version of the guidelines and the second—the number of environmental, social and economic indicators, the conceptualization of these indicators and the consideration of integrative indicators. The evolution of the guidelines suggests a concept of SD which appears to fail in the integration of the three pillars (economic, environmental and social). Furthermore, it requires a reflection on the origins of the concept of SD.3 By reviewing the origins of the SD concept and contrasting the latest version of the GRI guidelines (2002) some explanations can be found for a better understanding of the concept.

Possible explanations could be tied to the criticism that SD is a vague concept (Atapattu, 2002 and Bebbington, 2001) or to the criticism that the conceptions and the use of the concept of SD are environmentally biased (see Bebbington, 2001; Bebbington & Gray, 2000). However, the shift from the original conception within Agenda 214 – that set a two-part division between the socio-economic and the biophysical spheres – to the current three pillars of sustainable development could provide an explanation of what is going on. This shift as Upton (2002) remarks, can lead to a world where everything is tradable and emptying SD of content by seeking to extend it to everything.

In such a disconcerting state of affairs, the concepts of weak and strong sustainability (Bebbington, 2001; Bebbington & Thomson, 1996) suggest essential elements to assess the organizational behaviour and progress towards sustainability. Additionally, these concepts can fit for the practical purpose of making an appraisal of the conceptual position adopted – or elaborated along with the ongoing process of development – by the GRI guidelines concerning SD/sustainability. This article extends prior research, particularly, in two significant ways. First, revisiting the main topics of controversy around SD to get a better understanding of the concept of SD handled in the GRI guidelines. Second, providing some arguments to discuss and interpret the current immobilization related to the integration of the three pillars of sustainability, using the theoretical distinction between administrative and institutional reforms.

We proceed as follows. The next section illustrates the controversy around the concept of SD and explores the role that financial accounting can/cannot play in the building process of SD, scrutinizing the contribution of social and environmental reporting for this purpose. The third section addresses the particular case of corporate social reporting (CSR) and the TBL approach adopted in the GRI guidelines. The fourth section assesses the concept of SD/sustainability handled in the GRI guidelines, analysing the conceptual framework of the guidelines and the performance indicators. Finally, we discuss and draw conclusions on the concept of SD/sustainability constructed and developed by the GRI. For illustrative purposes, the paper extracts information from some GRI reporters.

2. Sustainable development and corporate reporting

Recent years have been witness to the coming to prominence of expressions such as sustainability or sustainable development, which have become important issues within the political and organizational agenda. Undoubtedly, the publication of the Brundtland Report in 1987 and the subsequent Summits of Rio and Johannesburg supported by the United Nations have helped to bring about the development of a shared consciousness about the need to reflect deeply on the ways society can contribute to social welfare without threatening survival of the earth. It is possible to find many definitions of SD in the academic literature and in institutional documents, but the most widely accepted is that proposed in the Brundtland Report: “Development that meets the needs of the present without compromising the ability of future generations to meet their own needs”.

However, as Eden (2000, p. 111) indicates, the only thing about sustainability that academics seem to agree upon is that there is no clear meaning or definition and this is part of the problem and part of the attraction for policy-makers and lobbying groups (Springett, 2003): sustainability can be made to mean what one would like it to mean.

Tags: Corporate unsustainability

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Concept of Social and Environmental Sustainable Development

The concept of sustainable development has become pre-eminent in the discussions on the relationship between humankind and nature. However, it has often been noted that there appears to be no common understanding either on the definition of sustainable development or on the possible measures needed to be taken in order to achieve it.

Although sustainable development also has older roots, it is usually assumed to have originated in the Brundtland Report Our Common Future by the United Nations World Commission on Environment and Development of 1987. In the report, sustainable development was defined as “development which meets the needs of the present without compromising the ability of future generations to meet their own needs”. Thereafter, the concept has gained widespread support as an appropriate policy goal for humankind. There seems to be some kind of consensus that the present way of living is not sustainable. Hajer (1997, pp. 13, 14) maintains that “environmental conflict is no longer about whether there is a crisis, it’s essentially about its interpretation.” Accordingly, there is an ongoing debate about how seriously unsustainable the current social practices are and what kind of measures should be taken in order to achieve sustainable development.

The role of the companies in achieving sustainable development has been a subject of lively discussion over the last decade, and the considerable increase in the quantity of corporate disclosures relating to environmental and social issues is well documented in the literature. However, there have been recent calls to move beyond descriptive research towards studies which would create a more qualitative understanding of what the reports are actually saying. In another context, Bebbington (2001, p. 129) has noted that the concept of sustainable development has been used to mean “different things to different people in different contexts”. It has also been pointed out that business managers do not have a clear understanding of what sustainable development is about. This paper therefore aims to shed more light on how the concept of sustainable development is used in the business context by analysing how it is constructed in the disclosures of Finnish listed companies. This study extends the ideas of Springett, 2003a and Springett, 2003b, Bebbington (2001), Fineman (2001), Gray and Bebbington (2000), and Bebbington and Thomson (1996) by making business actors’ conceptions of sustainable development visible. It seeks to contribute by providing a further understanding of what corporations are actually saying in their disclosures on sustainable development thereby adding to a recent stream of research employing discourse analysis and other interpretive analytical approaches to deconstruct business interpretations of sustainable development.

The analysis commences with summaries of earlier literature on the various discourses of sustainable development and of the previous findings of how business conceptualises sustainable development. Next, the approach, method of analysis and the dataset are presented, followed by an analysis of the Finnish disclosures. Finally, the findings are discussed and some concluding remarks are made.

In the Brundtland Report, sustainable development was defined very loosely, and since that report, hosts of different definitions for the concept have emerged. This elusiveness has helped the concept to gain a predominant position in environmental and social discussions worldwide, as it has been possible to define the concept to suit one’s own purposes. Sustainable development has therefore increasingly been used to promote very different kinds of initiatives in different contexts. As the use of these sustainability-related phrases has become more and more widespread, their meanings and internal relations have tended to become increasingly blurry. The discussion around different definitions and wider interpretations of sustainable development is often simplified into a dichotomy, in which two broader, relatively discrete social discourses are present. These ideal types of environmental or sustainability views have been given various labels, such as ‘reformists’ and ‘radicals’; ‘technocentrics’ and ‘ecocentrics’, ‘business view’ and ‘public view’ on sustainability, ‘light (shallow) green’ and ‘deep green’, and ‘weak sustainability’ and ‘strong sustainability’. In this study, they will be referred to as ‘weak’ and ‘strong’ sustainability. These two distinct approaches to sustainability present different ideas on how severe the current environmental crisis actually is, how threatening it is to humankind and nature as a whole, and how society should react to these issues. Next, the differences will be discussed in more detail.

In weak sustainability environmental and social problems are perceived to be less severe than in the strong view. The issues are acknowledged, but they are not believed to cause fundamental problems to the continuity of human progress. Accordingly, it is assumed that society can solve the ecological crisis by addressing it within the current social structures and economic institutions. No radical paradigm shift is deemed necessary. Solutions will be found through learning and by developing the existing practices, e.g. market mechanisms. On the whole, a sustainable society is considered to be relatively easily achievable within a relatively short timeframe.

In weak sustainability, the prevailing way of living is mainly left unquestioned. Economic progress and further growth continue to be dominant goals of society, upon which other dimensions of sustainability are partly dependent. Sustainable development is presented as a sort of a holy grail, which will simultaneously endow society with further economic growth, environmental protection and social improvements, with little or no trade-offs. Nature is seen as manageable through science and technology and the relationship of humankind to nature is rather instrumental: nature provides society with resources which can be utilised to increase human welfare.

The critics of this weak sustainability are various. Most importantly, in strong sustainability it is argued that continuous growth is impossible and may need to be abandoned as a dominant goal. Economic growth is considered to be a major cause of the social and environmental problems and pursuing it any further will severely hinder society’s chances of achieving sustainable development.

Strong sustainability emphasises that humans are an integral part of nature. In contrast to the anthropocentric perspective of the weak view, strong sustainability often approaches sustainability from an ecocentric viewpoint, placing the biosphere as a whole at the centre of the analysis. Humankind should not attempt to manage nature, but try to live in harmony with the other species and the ecosystem in general. Furthermore, in contrast to the weak view, strong sustainability regards social aspects as being an integral part of sustainable development, and considers both intragenerational and intergenerational equity as important issues. On the whole, the social and environmental problems are deemed more structural, therefore requiring radical solutions. It is emphasised that the environmental and social problems we face today are due to the prevailing economic system, which must therefore be restructured in a major way.

Tags: sustainable development

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The effect of audit scope and auditor tenure on resource allocation decisions in local government audit engagements

Local governmental entities in the United States are usually required to prepare comprehensive annual financial reports (CAFR) which include the general purpose financial statements (GPFS) and combining and individual fund type and account group financial statements. (See Appendix A for explanations of these terms and a brief discussion of the local government audit environment in the United States.) These reports are generally subject to external audit; the reporting entity frequently has a choice of two levels of external audit scope. At a minimum, the auditor’s report must express an opinion on the GPFS and include an opinion as to whether the combining and individual fund and account group financial statements are stated fairly in all material respects in relation to the GPFS taken as a whole (limited scope engagements). Alternatively, the audit firm can expand its scope by expressing an opinion on the GPFS and on each of the combining and individual fund and account group financial statements (expanded scope engagements).

Given consistent audit quality and efficient production of the audit, audits of comprehensive annual financial reports must use more resources than audits of the general purpose financial statements only. Generally accepted auditing standards (GAAS) suggest those additional resources should be allocated in a particular manner. No previous study has examined local government audit production costs to determine whether auditors’ adjust their audit effort as expected when audit scope differs. Anecdotally, audit practitioners have expressed concern that the audit staff may over-audit limited scope engagements. That is, they may conduct an examination sufficient to express an opinion on the entire CAFR, regardless of the scope indicated in the engagement letter. (Prior to 1981, local governmental audits encompassed the entire CAFR. Limited scope engagements were not an option. Audit staff may not have modified the audit program sufficiently to accommodate the change in scope.) If audit resources are not reduced when the scope of the engagement narrows, practitioners may not be conducting audits of the GPFS in an efficient manner. Alternatively, the quality of audits of the entire CAFR may be lower than the quality of audits with a more limited scope.

Generally accepted auditing standards (GAAS) also suggest that initial audits of a specific client will require more resources than subsequent engagements. GAAS requires that certain additional steps be performed during an initial audit. Among these are an investigation of the beginning balances in the balance sheet accounts, communications with the previous auditor, review of the prior year working papers (if any), and review and documentation of the client’s accounting system and internal controls. In addition to these initial audit start-up costs, a learning effect may result in auditor efficiency increasing with auditor tenure. As members of the audit staff become increasingly familiar with a client, they may perform their tasks more efficiently, reducing the overall audit costs. Start-up costs should be concentrated in the initial year of a continuing engagement; the learning effect may result in costs decreasing over a longer period of time. GAAS suggests that the additional resources expended on initial engagements be allocated in a particular manner.

While the presence of initial audit start-up costs may seem intuitively obvious, consistent empirical evidence has not been found by previous researchers using cross-sectional study designs. O’Keefe et al., 1994 T.B. O’Keefe, D.A. Simunic and M.T. Stein, The production of audit services: Evidence from a major public accounting firm, Journal of Accounting Research (1994) (Autumn), pp. 241–261.O’Keefe, Simunic, and Stein (1994) find no systematic pattern of labor hours across auditor tenure in a study of the hours employed in the audits conducted by a Big Six accounting firm during 1989. Conversely, Deis and Giroux (1996) find audit hours to be significantly higher on initial engagements in a cross-sectional study of 232 Texas school districts. Direct evidence of audit start-up costs has been limited because cost information is considered proprietary and is not generally made public by audit firms. A regional audit firm has made available for this study the actual production costs of their governmental audits over a 6-year period. This panel of data allows a longitudinal examination of audit costs across 49 audit clients.

I examine the relationship between audit scope, auditor tenure, and certain other engagement characteristics and the hours of labor charged to audit activities (e.g. planning, internal control evaluation and testing, etc.) by a regional public accounting firm across a sample of governmental audits. I find that more resources are used on expanded scope and initial engagements and that they are generally allocated in the expected manner across audit activities.

Because production cost information is not publicly available, relatively few studies directly examine the determinants of audit hours. Hackenbrack and Knechel (1997) perform a study which examines the determinants of labor hours charged by a single audit firm to particular audit activities across a number of client industries. My research provides similar insight into the production of governmental audits.

Of course, the interpretation of this study depends on the ability to generalize one regional firm’s resource allocation behavior to the population of municipal audits as a whole. Because audit production costs are not publicly available, studies such as this must expand knowledge by examining one audit firm at a time. This research expands the knowledge obtained by similar studies such as O’Keefe et al. (1994) and Hackenbrack and Knechel (1997).

1. Hypotheses development

1.1. Audit scope

The governmental entities included in this analysis are required to prepare comprehensive annual financial reports (CAFR) which include the general purpose financial statements (GPFS) and combining and individual fund type and account group financial statements. These reports are subject to external audit; the reporting entity has a choice of two levels of external audit scope. At a minimum, the auditor’s report must express an opinion on the GPFS and include an opinion as to whether the combining and individual fund and account group financial statements are stated fairly in all material respects in relation to the GPFS taken as a whole. Alternatively, the audit firm can expand its scope by expressing an opinion on the GPFS and on each of the combining and individual fund and account group financial statements.

If the entity requests an audit opinion on the GPFS taken as a whole, “existing audit practice is that audit scope should be set and materiality evaluations should be applied at the fund type and account group level” (AICPA, 1986, p. 37). “If the auditor is engaged to examine the combining and individual fund and account group financial statements in addition to the GPFS, the auditor’s opinion addresses each presentation as a primary statement. Ordinarily, in such circumstances the auditor will need to expand the auditing procedures applied …,” (AICPA, 1986, p. 150) because materiality will be evaluated separately for each individual fund and account group. An increase in audit scope to encompass the separate combining and individual fund and account group financial statements should consequently require an increase in the total amount of time necessary to perform the audit.

A review of the AICPA Audit and Accounting Guide, “Audits of State and Local Governmental Units,” suggests several functional areas of the audit which should be affected by the audit scope. In planning the audit approach, the auditor should develop preliminary estimates of materiality. When the audit scope encompasses the combining and individual fund financial statements, separate materiality levels must be estimated for each individual fund, rather than for each fund type. Audit procedures must also be planned for each fund, whereas some smaller funds may not be considered material when an opinion is expressed on the GPFS taken as a whole. Consequently, the amount of time expended on audit planning is expected to be greater when the scope includes the combining and individual funds and account groups.

Tags: Gudit engagements

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The evolution of annual reporting practices of an electricity firm

Accounting is influenced by the context in which it operates (Burchell, Clubb, & Hopwood, 1985; Carnegie, 1993, Gilling, 1976, Hopwood, 1983, Hopwood, 1990 and Napier, 1989). In this view, Gray and Haslam (1990) posit that changes in reporting practice can be expected during periods in which an organisation faces environmental stress and uncertainty. In a study of the United Kingdom (UK) Electricity Boards, Thomson (1993) found that over the period of privatisation, the presentation of financial and other information in the accounts changed. In particular, she referred to a switch from current cost to historic cost accounting but also noted the loss of supplementary information, such as performance indicators.

In the mid-1980s, growing concern about New Zealand’s economic performance, particularly in the public sector, led to wide-ranging economic reforms which emphasised increased public sector accountability. At this time electricity distribution and supply was the responsibility of electricity supply authorities (ESAs) which were managed by boards elected at local body elections. To improve performance in the industry, the New Zealand Government introduced commercial discipline to ESAs. This “shaped their organisational reality” (Roberts & Scapens, 1985, p. 455) and affected reported information.

In examining the interaction between accounting and its environment, we draw on contextual change by identifying a series of regulatory events that influenced change, and determine their impact on annual reporting1 from 1988 to 2001, focusing on the largest electricity network company in New Zealand, Waitemata Electric Power Board2 (WEPB). We also identify how accounting affected the environment during this period. This is a study of accounting and not a study in accounting.3

The remainder of the paper is organised in four sections. The first section provides a framework for the study by considering the theory of accounting change. The next section explains the research design and the significant events during the study period. The third section discusses the interaction between accounting and its environment. Some concluding remarks are in the final section.

2. Accounting change

Hopwood (1983) pointed out that accounting and organisational functioning are intertwined. This concept was examined further by Burchell et al. (1985, p. 32) who provided evidence of how “wider social forces can impinge upon and change accounting”. Since then other researchers4 have studied the factors that influence accounting change and the way in which accounting (particularly internal accounting systems) responds to a change in organisational culture or the operating environment of the organisation. These studies fall into three related groups. The first group examined the influence of external factors on accounting practice and how changes in the environment in which an organisation operates lead to changes in accounting. In this respect, Gray and Haslam (1990) described how the external reporting of UK universities responded to changes in the environment in which they operated. For this purpose, Gray and Haslam (1990) used a framework which incorporated three elements: the reporting organisation; an information output (for example, the annual report); and the “substantial environment” in which the organisation operates (p. 53). Bhimani (1993) described how factors external to the enterprise influenced the accounting practices of the French motor car manufacturer, Renault. He concluded that rather than being progressive, accounting change stems from definite causes. Although he acknowledged that accounting change is partly the result of managers exercising choices (see Watts & Zimmerman, 1986), he considered the basis of choice to be grounded in socio-historical circumstances. Thomson (1993) examined changes in annual reporting by privatised UK electricity companies. She found that the competitive environment resulted in a change in attitude to the disclosure of voluntary information. In these studies, the focus was on the influence of the changing external environment in which the organisation operated.

The second group emphasised the need to understand accounting and accounting change in the context in which they operate (Carnegie & Napier, 1996). Dent (1991) studied the influence of new accounting systems on the formation of a new organisational culture and found that accounting practice changed management behaviour and was a significant factor in developing the new organisational form. Similarly, Skaerbaek and Melander (2004, p. 17) examined the role of accounting in the privatisation of a Danish government-owned company in which the context changed from one of control to one of “financialisation”, as the entity sought to attract funding from institutional investors. Further, Ogden (1995) and Ogden and Anderson (1999) examined how accounting by privatised UK water authorities changed to reflect changes in management philosophy, management style, and an emerging focus on profitability. These studies focus on the changing internal environment of organisations and they provide insights to the privatisation process, the importance of profit, and the potential for accounting to contribute to (and shape) organisational change.

The third group of studies explored the historical and social context of accounting. In particular, Neu (1992) examined the impact of social factors on management choice of accounting practice, and Bryer, 1993 R.A. Bryer, The late nineteenth-century revolution in financial reporting: Accounting for the rise of investor or managerial capitalism, Accounting, Organizations and Society 18 (1993), pp. 649–690. Abstract Bryer, 1993 and Bryer, 2000 provided an historical study of accounting change in the transition to capitalism in the UK. Burns (2000) and Scott et al. (2004) provided insights to social and political influences on accounting change. These studies explore dimensions of change over time and the ability of accounting to create different images of an organisation and its relationship with its environment.

The current study is motivated by the findings of these prior studies which highlight interactions between accounting and environment. A common theme in the findings of those studies is that accounting is an “element of social and organisation context” (Napier, 1989, p. 244) and is influenced by the environment in which it is embedded. Another theme is the power of accounting to influence its environment. The current study examines the interaction between accounting and the changes in the regulatory environment of an electrical utility, with particular emphasis on external reporting. The focus is similar to that of Gray and Haslam (1990), as we examine the reporting organisation, the annual report, and the environment in which the organisation operated.

As depicted in Fig. 1, changes in the regulatory environment could have implications for the firm’s choice of accounting policies and practices. New legislation could directly impose additional disclosure requirements, or change the nature of the firm. This, in turn, could cause changes in accounting policies and practices, requiring internal organisational changes. On the other hand, the accounting practices adopted could influence the regulatory environment and cause organisational change. For example, a firm could choose a particular set of accounting and reporting practices to convince regulators it is behaving in a responsible manner and discharging accountability to its stakeholders, thereby avoiding further regulatory control. Finally, organisational changes could influence the regulatory environment. For example, when organisations change from being service providers to commercial enterprises in a competitive environment, they are controlled more by market forces than by government regulation. In this study, we focus on how changes in the regulatory environment are likely to influence accounting policy and practices of an organisation.

Tags: Electricity firm

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