For fun, I like to read audit reports. Not just any audit reports, mind, I like to read the last audit reports prepared by accountants on failed and failing companies. I want to see if they called it right for the shareholders. If you read between the lines of gobbledygook do you see something that sounds like “this company is at serious risk of going t*ts up in the next year”? That would be kind of useful to know if you’re an investor in a company at risk, no? Well let me put you out of your misery. I looked at the Lehman Brothers Annual Report produced in February 2008. According to the accountants, Ernst and Young,  things could simply not be better. Six months later – Lehmans is llama fodder (I forced that alliteration, can you tell?). However GM did NOT get a clean bill of health from Deloitte and Touche. No siree, Bob! D and T were really concerned about three elements of internal control breakdown and they made sure that they were communicated to the public. These were; 1) period end reporting controls were ineffective 2) compliance with SFAS 109 – accounting for income taxes – was ineffective and 3)controls over accounting for employee benefits were ineffective. Scary stuff!!

What about the CEO going cap-in-hand to congress begging for a handout within a year?

Nope, not a whisper.

Accountants are now whining because certain politicians and commentators are laying the blame for the sub-prime crisis at their door. Not because they didn’t warn about the risk, mind you, which, of course, they didn’t. No, it was because they changed rules recently to require “mark-to-market” or “fair value” accounting of investments. After decades of conservatism during which accountants argued that market values were unreliable and temporary, they did a complete volte face and decided that investments needed to be valued at what the market would pay. And they did this just before markets started behaving like a headless chicken. Anyone who believes that markets represent value today needs expensive psychotherapy. But, you know, I wouldn’t hold accountants responsible for the sub-prime crisis. After all, they were just the messengers in the end and they don’t deserve to be shot for that particular miscall. Not when we can find them guilty of lots more serious transgressions for which they should all be sentenced to follow Arthur Anderson into auditor oblivion.

Am I being too harsh? Am I expecting more of the accountants than I do all the other financial and management gurus that did not see the subprime tsunami on the horizon? Would anyone have believed them if they had cried wolf anyway? Well, let me put this into perspective a bit. There are mountains of rules and regulations that govern the way that financial information is reported to the public. And in spite of (maybe because of) all these, we are no closer today to a financial report that tells it like it is than we were a hundred years ago. Here is why: All these reports are aimed at fulfilling two competing objectives; consistency, so that one financial report can be compared to another and flexibility, so that the rules don’t get in the way of a report on the real condition of the business. In the end, the result is a miserable failure to achieve either objective. Enron is fading into the mist but the reporting fiasco that underpinned that spectacular failure was born of more or less the same system we live with today. The bottom line is that audit firms are not supplying any useful information to the public- unless you don't define the imminent  loss of your entire investment as useful information.

But is there a better system? You bet there is! You see, every major company keeps two sets of books. The one that the world sees is the set from which are drawn the reports compliant with the rule-mountain that has grown over the decades. But every business uses internal numbers to manage what it does. Inside the organization there are reports on liquidity and the relative profitability of different products. There are budgets and forecasts and reports against how well they are being achieved. But all these reports are confidential. The reports that are really useful and interesting will never be seen by the general public. If there’s a serious weakness in the condition of the business, it will be front and centre in these reports. But do the auditors see them? You bet they do!! Do they share them with investors? On pain of serious lawsuits from the managers of the business, rarely if ever. If they come across something in these internal reports that gives them cause for concern, do they share it with the public? Not likely. Why? Because, if the information is soft – for example, if a manager were to report that the business would go bankrupt if sales were to fall by 20% in the next year – reporting that opinion might cause a flight from the company’s shares and actually bring about the demise of the business. Silence is safer.

Here is the moral of the tale. There are two types of accounting, financial and management. Management accounting is not subject to any rules except that it should be useful. Financial accounting is burdened with a mountain of rules which, despite the honest intentions of everyone involved, ensures that the resulting information is completely useless.

We’re here to help you develop good management accounting techniques. You need to have numbers that help you make the business work. The only reports that matter are the ones that are fast, accurate and about now and tomorrow. You can’t manage yesterday. Historical financial reports are for historians and tax collectors.

So some accountants are useful.

Like us.