Sue Newberry is a senior lecturer in financial accounting at the University of Canterbury.

Part I of the review makes the usual claims that accountants like to make about financial reporting, and what may be achieved through standardised and legally enforceable financial reporting standards (paras. 26-58). The suggestion is that, although financial reports are technical, understanding them is quite straightforward for anyone who knows the basic financial reporting framework and the level of discretion available within that framework. With this understanding, accountability will be achieved and sensible financial decisions may be made, thus enhancing public confidence. Over the last few years, the Institute of Chartered Accountants of New Zealand has made several efforts to maintain and enhance public confidence in financial reporting. Evidently, this is because "public confidence in the integrity of the financial reporting framework is…central to maintaining and expanding a sophisticated domestic capital market" (para. 33). It is also central to the accounting profession’s perceived legitimacy.

A feature of the recent corporate collapses and scandals was that the audited financial reports issued by the companies concerned before they collapsed (Enron, in the US, for example) did comply with financial reporting standards. Complex financial engineering deals had helped to provide the means to comply with financial reporting standards, hide a growing mountain of debt off-balance sheet, and present a positive image to shareholders. Another scandalous feature of these collapses was the complicity of merchant bankers, financial analysts and major chartered accountancy firms, all of which earned large fees from their involvement. One set of financial reporting standards for application worldwide won’t stop that happening. Instead, it seems possible that one set of financial reporting standards would allow these players to earn even richer pickings by replicating their financial engineering deals worldwide. They already do so now, but those deals have to be modified to fit within each country’s specific rules. It would be so much easier to have one set of rules worldwide and replicate costlessly.

Globalised business is well-recognised as accompanied by globalised financial and other crime. The behaviour associated with Enron is now widely regarded as criminal and some former Enron staff have appeared before the US courts. Some of the dubious practices Enron engaged in were widespread by the time Enron collapsed in late 2001. In early 2002, Global Crossing, a US telecommunications company, also collapsed. With public sensitivities to dubious deals already heightened, some of Global Crossing’s deals drew media attention. One company named as a counterparty to some Global Crossing deals was Telecom New Zealand Ltd and this drew media attention here.

A growing body of literature argues that financial reports and financial reporting practices are intended to deceive. This deception allows those in powerful positions to maintain their power by keeping ignorant those who are less powerful). A cynic summarising this literature might refer to financial reports as weapons of mass deception. Techniques used in this mass deception process include advertising practices and financial manipulations.

An example drawn from Telecom’s 30 June 2001 Annual Report illustrates the deceptiveness of advertising techniques and financial manipulations. The Chairman’s Report in the glossy front section of Telecom’s Annual Report described as "splendid" Telecom’s investment in Southern Cross Cables Holdings, an associate company based in Bermuda (a tax haven). And splendid it seemed. Earlier, Telecom had invested $45 million in shares in three associated companies, one of which was Southern Cross. In 2001, Southern Cross paid Telecom a dividend of $263 million. Few share investments return such massive dividends, and this dividend increased Telecom’s reported after tax profits for 2001 by 52% or $221 million (total reported profit after reported tax expense for that year was $643 million. Without the dividend, it would have been $422 million).

Closer scrutiny of Telecom’s financial reports revealed that all three associate companies had incurred losses so great that Telecom’s portion of their losses exceeded its investment in their shares. In the same year that Telecom received the $263 million dividend from Southern Cross, Telecom also wrote down to zero its share investment in all three associate companies, including Southern Cross. This was because of the losses, but it had the effect of changing the accounting requirements between them and Telecom. It meant that all three became the New Zealand equivalents of Enron-style off-balance sheet entities. Our financial reporting standards require this!

Just months after Telecom published its audited Annual Report for 2001, Enron collapsed and circular transactions using special purpose off-balance sheet entities became notorious. The international fallout gave rise to claims in New Zealand that our financial reporting standards made sense and wouldn’t allow such deals to be concealed, and the Securities Commission rescued Telecom.

That collapse also led to inquiries internationally into professional practices and conflicts of interests, and announcements of changes to improve corporate governance. The Institute of Chartered Accountants of New Zealand launched a "Corporate Transparency" project in an effort to maintain confidence in corporate reporting and capital markets. Sad to say, "maintaining a con" might be a better description of that project, and of the current review of the Financial Reporting Act.

The idea that financial reports are intended to deceive is well worth remembering. At the very least it promotes a healthy scepticism towards published (and audited) financial reports. Financial reporting has not improved since 2002, and Telecom’s Annual Reports continue to illustrate the need for scepticism. Telecom’s 2003 Annual Report revealed a $2.1 billion transaction in intangibles between Telecom and a subsidiary. As noted in the 2003 Roger Award Judges’ Report, the resulting arrangement provided "a perfect set-up for…raising debt off-balance sheet, then boasting about strong cash flows and debt reduction". Telecom’s 2004 results announcement reports cash flows so strong that debt has been reduced significantly and increased dividend payouts are to be made. Are Telecom’s improvements genuine? Alternatively, do those improved results come from off-balance sheet debt, circular transactions and deceptive financial reporting?

We in New Zealand, along with Australia, are rushing headlong into a single set of financial reporting standards being prepared for global application. Other countries are not in such a hurry and seem less inclined to apply the standards comprehensively (para. 42). For all the claims that these standards represent "best practice", my observation of the pressured efforts by the international standard-setter to achieve a "stable platform" of standards by March 2004, leads me to believe that the standards will increase, rather than decrease, the scope for financial manipulation and deception.

Part I of the review contains three explanations for our rush into global standards that I think best describe the current developments. Obviously, the need to maintain public confidence in capital markets provides one important explanation. A collapse of confidence in capital markets could be devastating. The other two important explanations are covered in one paragraph of the review:

"…In addition, there are reduced compliance costs for multinational corporations because financial reports filed by subsidiaries for local regulatory purposes are prepared according to the same set of standards as the reports prepared for their parents for consolidation purposes. Finally, accounting skills learned in one jurisdiction may be more readily transferable to other countries (para. 40)…"

Evidently, the major beneficiaries of this single set of financial reporting standards are transnational corporations and the transnational chartered accountancy firms. Note that accounting services was one of the first financial services to be liberalised under the General Agreement on Trade in Services (GATS) regime and that this regime is designed to benefit transnational corporations seeking business opportunities internationally. Arguably, this helps to explain why the review seems based on the ideas that business compliance costs should be reduced, that foreign-owned companies should not be subject to conditions any more stringent than those of domestic companies, and that foreign direct investment in New Zealand is automatically good.

This global financial reporting framework is nothing more than a mishmash of financial reporting practices developed over centuries for domestic profit-seeking businesses, but now applied on a world wide basis. It assumes a legal structure and culture that does not necessarily exist in all countries and, having developed from a domestic base, does not consider the effects transnational companies may have in other countries or identify any need for reporting on them. Amounts invested in New Zealand-based industry will be reported and highlighted, but amounts and resources transferred out of New Zealand will remain largely invisible. This financial reporting framework will increase New Zealand’s vulnerability to exploitation.

Part I of the review refers to entity and sector neutrality. This idea of neutrality is that the same mishmash of accounting and financial reporting techniques developed for domestic profit-oriented businesses can and should be applied to the whole economy, the public and nonprofit sectors alike. Governments and government departments, and charities, churches and sports clubs which typify the public and private sectors did not evolve for profit-making purposes. Their existence and their reasons for financial controls and reporting are different, and the appropriateness of applying the same regime to all is controversial.

Over the last twelve to fifteen years, both New Zealand and Australia have been the world’s laboratory rats for public sector financial management reforms. Financial reporting standard-setters in both countries have claimed, falsely, that the financial reporting requirements imposed on the public sector are "sector neutral." Actually, the financial reporting requirements applied to the public sector are biased and selective when compared with those applied to the private sector, and work to the detriment of the public sector. The determination with which this experiment has proceeded and the closed approach adopted to financial reporting standard-setting has provoked mounting concern among some members of the accounting profession in both countries.

In both New Zealand and Australia, researchers have gradually exposed the nature of the biases. Now, they are beginning to demonstrate the way in which the biases and selectivity privilege neo-liberal ideas and function as a form of rigging. If the financial reporting requirements are applied without knowledge of the rigging, the resulting numbers help to "prove" that the private sector is more efficient when compared to the public sector. The financial reports function as weapons of mass deception to convince the wider public that the neo-liberal view of the world is correct.

More recently in Australia, the claim has been made that the selectivity has concealed corruption by hiding the extent to which public sector financial management reforms assist the movement of public assets into the private sector. We have much the same reporting requirements in New Zealand but, as yet, no one in New Zealand has gone quite so far with claims of corruption.

A requirement for a single global set of financial reporting standards would mean that even sole trader corner dairies and tiny clubs would be forced to comply with complicated financial reporting standards devised for large businesses. Because that is impractical, Part I proposes a tiered regime, developing the idea that exemptions should be allowed for small and medium entities. It identifies a set of characteristics distinctive to those entities (para. 61):

• The business is managed by its owners;
• It has limited internal sources of specialist advice;
• Trade debtors and creditors comprise most of the total assets and liabilities; and
• It often relies on short-term loans or overdrafts rather than shareholder capital to finance its assets.

Although those characteristics might typify small and medium entities and, at least superficially, might make sense for developing a tiered reporting regime, the same characteristics also typify the sorts of entities used as off-balance sheet vehicles. How the tiered reporting regime is developed will be important.

The report acknowledges that New Zealand’s existing tiered reporting regime includes reporting requirements for companies with subsidiaries, and for foreign-owned companies (para. 98). It drops the existence of subsidiaries as grounds for requiring full reporting and reduces in importance foreign ownership. Instead it proposes a set of four criteria to determine application of these tiered reporting requirements (para. 108). These criteria seem likely to extend into auditing and filing requirements.

Several matters of concern arise from this Part I review of the Financial Reporting Act. The need to maintain confidence in financial markets is very important, but it is worth considering whether the current financial reporting regime, along with the move to a single global financial reporting framework, will provide the benefits assumed. If maintaining confidence amounts to little more than maintaining a con, then any benefits claimed will inevitably be short-lived. There is nothing in existing financial reporting standards that will overcome or help to prevent the sorts of corporate collapses and scandals we have seen recently, and the worldwide application of a single set of standards will not change that. Instead, it seems likely to increase vulnerability to such events and to globalise their effects. Even proponents of this single framework have acknowledged this danger.

There should be no sympathy with the desire to reduce compliance costs for major companies, whether transnational or domestic. The solution to high compliance costs is in their own hands. Compliance costs would be reduced significantly if simpler rather than highly complex structures and transactions were adopted and if the Annual Reports reverted to straightforward information disclosure instead of propaganda. A reduction in compliance costs will mean a reduction in financial reporting and even more deceptive financial reports. The underlying philosophy seeking to reduce compliance costs for companies should be challenged.

If we continue to set financial reporting standards in New Zealand, we do at least retain a level of sovereignty over our lawmaking processes whereas we will lose that sovereignty by adopting the international standards. Both sets of standards though have been developed from domestic practices related to profit-seeking motives. Both ignore the potential effects on citizens of transnational company activities. In this respect both frameworks are very similar. Their suitability for a global trading regime seems to be taken for granted, but it should be questioned.

This developing financial reporting framework is just one of a range of linked, seemingly technical regulatory developments highly consistent with each other. Taken together, these might be regarded as representing the re-emergence of the Multilateral Agreement on Investment (the notorious MAI, which was defeated by global opposition, in 1998. Ed.). This time it seems to be emerging gradually and by stealth but, eventually, we can expect these regulatory developments to be brought together as one global framework of rules. As is apparent from the review of the Financial Reporting Act, the major beneficiaries of these rules seem to be transnational corporations. Once in place, this global framework will have an effect on all our lives. It is therefore, essential, that the development of these rules not be left to those promoting them simply because the rules seem technical.