New Zealand lags US in accountancy standards and safeguard legislation

By Alan J Robb and Sue M Newberry

Friday 26th July 2002

Telecom's decision to bar its external auditor from providing advisory services is to be welcomed and should become the norm if credibility in financial statements is to be enhanced.

PricewaterhouseCoopers (PWC) has retained Telecom's consultancy work but will no longer be the auditor after the current financial year. By appointing KPMG as the new auditor, Telecom's board is exercising good governance and ensuring fresh eyes are brought to bear on the company's operations.

It is doubtful if Telecom would have been happy for PWC to continue as auditor because of the possible perception of its American institutional investors.

In the US this week PWC paid $US5 million to the Securities and Exchange Commission to settle charges that suggested that it may have been swayed in its audit by fees it was paid for non-audit service. Other charges related to the improper accounting treatment of advisory fees paid to PWC. No such suggestions have been made against the New Zealand auditors but the possibility existed that some American investors might misunderstand that fact.

Telecom's chief financial officer, Marko Bogoievski, said that the way Telecom was perceived by its large investors overseas was "critical." In other words the credibility of financial reports was the central issue.

In our opinion financial credibility depends upon several things including the separation of audit and advisory services.

Last February, following the collapse of Enron, the accounting profession was reluctant to acknowledge any perceived conflict between audit and consultancy work. "Separating consulting practices from audits isn't the real answer," Ralph Marshall, president of the Institute of Chartered Accountants, said.

The separation is now occurring on a worldwide basis and Telecom is leading the way here in recognising that investors may not share the profession's official view. It may be noted that some of the smaller audit firms publicly challenged the institute's view suggesting that they were more in touch with public concern.

Many of the American accounting scandals have arisen because of complex financing structures involving off balance sheet entities. They affected both the assets and the liabilities reported in balance sheets. They were usually the creation of same firm which audited the company. "If you are auditing your own creations, it is very difficult to criticise them," Robert Willens, a Lehman Brothers tax expert, said.

As was pointed out earlier this year (NBR, March 15), Telecom's results and reported gearing have been materially affected by its use of off-balance- sheet associates, prepaid cross border finance leases and purchase and sale deals of cable capacity. PWC gave the company a clean audit report and an investigation by the Securities Commission cleared the latter two accounting policies.

Enron, and others, kept many transactions off balance sheet, while complying with accounting standards. New Zealand standards, even recent ones such as FRS-38 Accounting for Investments in Associates, provide officially sanctioned methods for using off-balance-sheet entities to manipulate earnings and financial position.

Quite apart from off-balance-sheet structures, financial reports have lacked credibility because of some of the assets and liabilities that have been disclosed, always in accordance with accounting standards.

Claims have been made that New Zealand's principles-based accounting standards are better than those in the US. This is not so. The concept of assets is so flexible that mere expectations about the future can masquerade on a balance sheet as things of value. Then the crunch comes and they have to be written off. Lucent Technologies is writing off $US5.83 billion of deferred tax assets because, it says American accounting standards now place "greater weight on present woes than on future hopes." Tranz Rail is similarly writing off deferred tax assets.

New Zealand standards allow just as many future hopes of management to window dress our balance sheets. Credibility will be improved when all balance sheets are purged of such fictitious assets.

We suggest that both the Financial Standards Board and the Accounting Standards Review Board owe it to New Zealand investors to ensure that our financial reports show present facts and not future hopes.

In February New Zealand's Securities Commission acted promptly to investigate Telecom's half-year report. Its decision agreeing with the accounting practices has never been followed by any analysis of the reasons for its conclusions. It must be noted that one of the practices the commission cleared as consistent with generally acceptable accounting practice bears a striking resemblance to practices at Worldcom that the SEC in the US is prosecuting as fraudulent. For the credibility of New Zealand financial reporting practices some explanation and analysis is essential.

Another area for restoring credibility also rests with the Securities Commission. In the US the SEC provides a complaint centre or hotline service for those concerned with the accounting practices of American companies. Each email tip is investigated fully by an SEC lawyer. The director of enforcement, Steve Cutler, said some of the accounting complaints come from company insiders pointing the finger at colleagues for allegedly cooking the books. In March the centre received more than 12,000 email messages.

The SEC should be congratulated both on prosecuting accounting scandals and in providing a system for concerned shareholders to get some action. The auditing profession has a poor record for detecting fraud and manipulation. The independence of the SEC from the accounting and auditing industry would seem important in restoring credibility. The time is right for a similar system here.

Alan Robb is a senior lecturer and Sue Newberry a lecturer in accountacy at the University of Canterbury

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