Public Sector

The �pussycat� roars

The UK National Audit Office and the Charity Commission have demanded stricter compliance with good accounting practices. The NAO has qualified the accounts of 16 government departments, highlighting poor record keeping. And the Charity Commission has warned that many charities are mismanaging their reserves.

Government departments have been required to use resource accounting as their sole accounting systems since 2001/2, after a period of transition in which both cash and resource accounts were used. The NAO says that while most departments have moved efficiently to the new system, a minority are failing to adopt sufficiently rigorous management information systems.

Those departments whose accounts have been qualified for poor record keeping are the Home Office, the Ministry of Defence, the Department for Work and Pensions, the Department for Environment, Food and Rural Affairs, the Office for National Statistics and the security services. The inclusion of some of these is no surprise: the Department for Work and Pensions has repeatedly had its accounts qualified over the quality of its benefits processing; the Ministry of Defence struggled more than any public body with the introduction of resource accounting, with many problems over the valuation of its diverse range of assets; and the Department for Environment, Food and Rural Affairs has had to overcome the legacy of the foot-and-mouth disease and allegations of compensation fraud.

But the qualification of the other departments is a humiliation for them, particularly for the Office for National Statistics whose entire raison d�etre is founded on the public�s ability to trust its figures. A further 10 departments have had their accounts qualified because of over-spending, including the Charity Commission, the Royal Mint and the Serious Fraud Office.

The comptroller and auditor-general Sir John Bourn - once memorably described by a retired permanent secretary as �a pussycat� - further asserted his independence by demanding that some departments develop their arrangements for corporate governance and risk management. He suggested that while the Higgs report on non-executive directors was aimed at the private sector, the recommendations could be regarded as having �great relevance for similar developments in the central government sector�.

Sir John also drew attention to the complexity involved in accounting for Private Finance Initiative projects. He added that this has not �to date� caused him to qualify any departmental accounts. His report put particular emphasis on his �concern� that in �a number of PFI deals� the assets and related liabilities did not appear on the accounts of the client or special purpose vehicle consortium supplying the services.

Significantly, Sir John further put a spotlight on the issue of contingent liabilities. He says that he will qualify departmental accounts where he believes they fail to show liabilities, including contingent liabilities. Specifically, he said that Network Rail should be regarded as a public body, with its assets and liabilities included in the consolidated balance sheet of its funder, the Strategic Rail Authority.

Meanwhile, the Charities Commission has found that many charities have weak financial management, accounting and corporate governance practices. At the end of 2001, charities in England and Wales had reserves in excess of £26bn, yet over £5.5bn of this was held by charities with no policy on the use or level of reserves. Often where policies had been adopted, these were inadequate. Charity trustees are legally required to publish in their annual report their charity�s reserve policy.

It appears that, in many cases, the reasons for charities� information failures are not so much negligence, as the desire to confuse donors. The Commission reports that some charities split reserves into smaller �designated� funds, hiding from stakeholders the real level of reserves or that reserves were held at levels higher than that specified by the reserves policy. Concern was also expressed at the one-third of charities holding reserves at levels lower than specified by their policies.

The issue of reserves has become more pressing because many charities have large investments in shares, the value of which have diminished sharply. The Commission is advising charities to account properly for their reserves on the basis of a balanced and transparent policy. Charities with insufficient reserves should consider income diversification and appeals which are directed at building reserves.

Shirley Scott, director of the Charity Finance Directors� Group, said: �Reserves are an indicator of health and sustainability in a charity and are an essential part of good financial planning. It is important that stakeholders should look beyond the headline figure of how much a charity has in reserves to examine why the charity is holding these reserves.

�Therefore, it is vitally important that all charities have carefully considered the reasons why the charity needs reserves, for example to bridge cash flow problems; what level - or range - of reserves trustees believe the charity needs; what steps the charity is going to take to establish or maintain reserves at the agreed level - or range; and arrangements for monitoring and reviewing the policy.�

The Charity Commission also issued a warning to charities, trustees and employees after the successful prosecution of a former solicitor for causing the loss of £311,000 to the Helston Downsland Charity. The charity�s clerk was found guilty of forgery and deception after stealing money by persuading trustees to sign blank cheques.

Companies not prepared for IASs

�Uncertainty and confusion� is plaguing the European financial service sector�s preparations for international accounting standards in 2005, says a new report from the Economist Intelligence Unit and PricewaterhouseCoopers.

The survey, Illuminating Value, says that executives remain unclear about the new standards, with justification as important standards on insurance contracts and financial instruments have still not been finalised.

Most worryingly, while 45% of survey respondents confirmed that they were required to comply with the new standards, only 34% said they would actually do so. Less than half of those who will have to use the new standards have begun implementation.

EIU and PwC say that companies which delay preparation for the new standards are exposing themselves to dangerous business risk as the standards will require significant changes in financial management. In particular, companies are advised to begin running parallel accounts using the new standards in advance of the 2005 compliance deadline. Companies which also have SEC reporting requirements may need to prepare three years of historical information for reconciliation with US GAAP.

Impacts of the new standards go beyond internal processes: companies have to change financial products, investment strategies and risk management policies. They must also educate and warn shareholders and investment analysts that the new standards will lead to much more volatile financial results.

�Banks, insurers and other institutions need to be prepared, and the highly compressed timetable for implementation leaves little time for reflection, much less for action,� concludes the report. �Financial services firms, not only in Europe but also outside it, need to act now both to assess the impact of IFRS [international financial reporting standards] on their operations and to start making preparations to adapt.�

The move to international standards also applies to the audit of financial statements, with the publication by the International Federation of Accountants (IFAC) of its proposed amendment of ISA 200, Objective and Principles Governing an Audit of Financial Statements. Its latest proposals have been described by ACCA as �extensive and procedural and their implementation would result in a disproportionately large extra cost for audits of smaller entities�.

In its response to IFAC�s proposals, ACCA called for any approved International Standards on Auditing to have the support of three-quarters of the membership of IAASB - not the two-thirds support as suggested by IFAC. This would send clear signals to the profession that any standards produced by the board had overwhelming international support, says ACCA.

ACCA has also called for the proposals to be clear and consistent and to be based on principles, rather than adopting an unwieldy, procedural �rule book� approach, which could lead to exploitation of loopholes, as demonstrated by the Enron scandal in the US.

ACCA President, Jonathan Beckerlegge, said: �While we welcome the approach adopted by IFAC, we believe it is vital that any proposed auditing standards should have the support of the overwhelming majority of IAASB to send out clear messages about the strength of feeling behind those standards. In turn, this should make enforcing those standards more straightforward.�

Stock options standards under fire

Share option schemes remain extremely popular amongst leading British corporations, despite proposed new accounting standards to treat them as company expenses. A survey published by Pinsent Curtis Biddle, legal advisers on employee share schemes, and the lobby group ProShare found that 91% of FTSE 350 companies provide share options to executive directors, while 52% award free shares on performance linked terms under incentive schemes.

The survey also found a growing trend among companies in paying bonuses as shares. But it warned that more than half of companies in the FTSE 350 are in breach of guidelines from the Association of British Insurers in failing to disclose a maximum limit on the initial value of share options.

David Pett, head of share schemes at Pinsents, said: �We have observed, over recent years, the introduction of new Inland Revenue approved share plans and also an emergence of other forms of share incentives which are more sophisticated than their predecessors. The share ownership culture remains strong in the UK and, despite the bear market we are currently experiencing, share incentives are evolving and continue to be firmly rooted in the culture of companies.�

However, it seems that both the International Accounting Standards Board and the Federal Accounting Standards Board remain set on a path that will expense stock options based on fair value. The FASB has announced that it will reconsider stock option accounting, making it likely that it will converge with the proposed IASB standards - probably from the beginning of 2004.