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Shaping the UK’s critical policy debate about regulation of accounting, auditing and corporate governance

This case study was produced as part of BU’s REF 2014 submission, made under unit of assessment 19 – Business and Management Studies. It was originally published in November 2013.

Research into 2003/5 changes to UK accounting, auditing and corporate governance regulation found major flaws in the regime. By providing evidence and lobbying via other organisations, researchers have exposed these defects and their implications, contributing to critical public debate around the policy.

This is evidenced by extensive discourse at the highest level, including the House of Lords Economic Affairs Committee (EAC), the Parliamentary Commission on Banking Standards (PCBS) and high profile media coverage.

The research

In 2007–8 BU’s Professor Stella Fearnley with two colleagues Beattie (Glasgow) and Hines (Portsmouth) investigated the effect of the UK 2003/5 regulatory changes for UK listed companies on auditor/company interactions and on the integrity of the financial reporting process.

The key research findings can be briefly summarised to include:

  • The accounting model (introduced into the EU in 2005) undermined the concepts of prudence, reliability and the true and fair view.
  • The overall regime was driven by compliance and box-ticking rather than professional judgment
  • The accounting model allowed major banks to overstate profits, thus contributing to the economic crisis.

The researchers revealed that, under the strengthened enforcement regime, CFOs, AEPs and ACCs are driven to comply with the new rules to satisfy the regulators, even though they may be uncomfortable with the outcomes and the amount of box ticking required for compliance. Low quality work has been improved, but good auditors do not go beyond what is required by the rules.

There is a significant concern in relation to IFRS accounting outcomes, as the complexity and pro-cyclicality of the accounting model had misreported profits and led to overstated results in the banking sector before and during the economic crisis. The complexity has also detached non-accountant users of financial statements, including directors, from their understanding of what the numbers mean. This is a risky and undesirable situation for all directors.

In particular the research identified which accounting and auditing issues preparers focused on and the level of engagement of audit committee chairs in the process. It became clear that the increased engagement of the audit committee in the audit process (P2) provides a buffer between auditors and the company executives, particularly the CFO, and has also improved some decision-making.

The researchers also concluded that the true and fair view of accounts, which has traditionally been the legal backstop available to directors and auditors to ensure accounts reflect the economic substance of a business, has been interpreted by directors and auditors in the revised framework to mean compliance with IFRS with all its failings.

Informing critical public policy debate

Fearnley and Beattie’s oral evidence to the House of Lords EAC in October 2010 was based on the research findings. Fearnley’s evidence (described by Lord Lawson as a ‘magnificent outburst’) along with Beattie’s, convinced the EAC to extend its brief beyond the role of auditors to the impact of the link between the regulatory changes, particularly accounting and the financial crisis.

EAC published its report on ‘Auditors: Market Concentration and their Role’ on Wednesday 30th March 2011. Citations to Fearnley and Beattie’s oral and (with Hines) written evidence, draw on the research project described here. The adverse impact of IFRS on financial reporting and auditing, appear in the report.

The outcome of the Inquiry included a challenge to the government policy on the quality of the IFRS accounting model. This would not have happened without Fearnley and Beattie’s initial intervention. Following the EAC Inquiry, Fearnley was invited to speak at the Conference of the French Autorite des Normes Comptables.

In 2012, Fearnley subsequently received two personal requests to submit written evidence to the Parliamentary Commission on Banking Standards (PCBS), which she did in conjunction with Sunder, and she gave oral evidence on 16 January 2013.

Following this evidence, which was reported in the Financial Times (R2) she was invited to speak at a seminar at the European Parliament in May 2013 on accounting issues. Following a report in the Financial Times, she published three invited articles: two for the Labour Party Finance and Industry Group Journal and one for the Association of International Accountants Journal.