Analysis – Complex accounting exists for a reason

Tom Ravlic

Buried in the transcripts of the inquiry into audit regulation is a little question that has annoyed me ever since it was uttered by Jason Falinski, the member for Mackellar and also a member of the Parliamentary Joint Committee on Corporations and Securities.

I had cause to go back and read through the Hansard of that particular inquiry again to refresh my memory on other matters and the Falinski contribution feels like a pebble stuck in a shoe every time I read it.

Falinski’s favourite question on accounting matters is: why are accounting standards so complex?

It is littered throughout the transcripts almost like confetti getting strewn around on the steps of a church after a wedding.

What is sometimes forgotten by critics of accounting regulation is that simple accounting is possible if the business and its model of running are simple.

Run a small concern that has no corporate group to get consolidated, few cash generating units, no foreign currency issues, uncomplicated share or ownership structures and as few contracts as possible and then you might have simple accounting.

Complex accounting actually arises from complexity in business in its own right so if people don’t like complex accounting then they may wish to reconsider their business model or whether they should be running a business at all.

Complexities come for the forefront, however, when businesses are more complex and financial institutions are not exception.

What people must also bear in mind in the case of complex business is that there are global regulators that may have a say in how accounting standards are shaped. Regulators can add complexity themselves because they have a wishlist.

Take the notion of expected credit losses that has been driving analysis and journalists around the bend lately given the heavy cloud cover on the business community that has been visible since the coronavirus hit our shores.

That particular change in accounting for businesses that lend money came about as a result of the global financial crisis and of prudential regulators wanting some kind of estimate upfront of banks’ expected loan defaults.

This straddles the territory on two accounting concepts that can be difficult to reconcile for some people. There are those that maintain that accounting should tell you what happens and any losses incurred – that is, loss that actually eventuates – ought to be brought to account.

The other approach is that estimating credit losses is attempting to project forward so that the market has come idea of what losses are expected.

Prudential regulators think in terms of prudence and that is about being risk averse. What crept into financial instruments accounting with estimated credit losses was in some respects positioning from regulators who wanted to incorporate things that companies believe might happen into financial reporting.

Business innovations consistently create challenges for financial reporting. Consider what happened when websites first came about and people were thinking about how you value ones and zeroes that find their way on people’s internet browsers.

Look at the considerations that evolved when people thought about what happens when you account for self-generating and regenerating assets like ewes that end up giving birth to lambs.

Falinski’s question had an element of flippancy about it and reflected the same kind of tone that I have heard from many a corporate accountant and practitioners of an older generation over 26 years.

There are multiple factors that drive complexity but the most significant driver is the type of business an owner chooses to run. Owners that run complex businesses deserve the complexity that comes with compliance.