BUSINESS OPINION:It would be incorrect to think that the accounting profession will not pay a price, particularly if the core problem is not addressed, writes JOHN McMANUS

A COLUMN in this paper last week by Vincent Browne summed up well the widespread bafflement over how the Irish banks could run up the sort of losses they did despite being audited every year by big accountancy firms. And, more pertinently, why the accountancy firms that carried out these audits seemed to have avoided any sort of censure.

The jumping-off point for the piece was the collapse last week of Bloxham stockbrokers, but it quickly moved on to the big banks. The author gleefully recited passages from the audit reports of the big banks that gave them the all-clear during the years running up to 2008 when horrendous losses were building up in their loan books.

Not surprisingly, the big accountancy firms were reluctant to comment. There is a logical, but somewhat technical, explanation for why the banks’ audited accounts were so misleading, but it opens a whole can of worms.

To paraphrase the British judge Lord Denning with respect to the Birmingham Six’s appeals, the explanation for why auditors cannot be blamed for the banking collapse opens up an “appalling vista”, in which the whole value of limited liability and statutory audit is called into question. And along with it the professional accountancy firms’ main reason for being.

But first the explanation: Audited company accounts are prepared under a set of rules known as the International Financial Reporting Standards (IFRS). They are an attempt to set a common approach so that, for example, German company accounts can be compared to Irish company accounts.

The problem is that, under the IFRS guidelines, banks can only recognise a loan as lossmaking once the borrower defaults. It does not matter what they might think, or what they might know about the borrower. If they are making repayments the loan is performing.

As explained by accountancy expert and author Cormac Butler in a piece in today’s business pages, this is incompatible with the basic premise of company law that accounts must give a true and fair view of a company’s position. The quid pro quo for making such accounts public is limited liability for directors, which means they cannot be personally pursued for the company debts.

However, the linkage between profits and bonuses in banking, combined with the IFRS guidelines, created the toxic scenario in which banks were in effect incentivised and required to hide their losses. The lid has now well and truly been blown off the problem, as Butler explains, but as yet no one is showing much enthusiasm for putting things to right.

The reason for the inertia is obvious. Admitting the error and fixing it would send shockwaves through the corporate world. There would be massive litigation risk, accounts would have to be restated for thousands of companies, accounting systems would have to be overhauled and a generation of accountants would have to be retrained.

It is of course easier to just keep going, and many propose that the solution is to bring company law into line with the existing IFRS, rather than changing the troublesome guidelines.

In the meantime, the status quo pertains and the large accountancy firms can claim correctly that their work on the Irish banks adhered to the existing accounting standards and still does. They did the job they were paid to do. This goes some way to explaining why the accountancy firms are not being blamed for the banking crisis.

But it would be incorrect to think that the profession will not pay a price, particularly if the core problem around the reporting of expected losses is not addressed.

Sophisticated users of audited company accounts will always tell you that they treat them with a grain of salt and that the real information is hidden in the pages and pages of notes that come after the balance sheet and the profit and loss account.

It is only to be expected that this cynicism will now spread even more widely, greatly diminishing the value of audited accounts as a business tool.

This has several logical consequences that may or may not play out over time. The first is that fees that companies pay auditors will have to come down to reflect the diminished value of the product, particularly in the case of financial companies.

The second is that the limited liability that is granted to the directors of companies that publish audited accounts should be qualified to reflect the fact that accounts do not necessarily give a true and fair view under company law, on which the limited liability is based.