Financial Reporting in the UK

A History of the Accounting Standards Committee, 1969-1990

B.A. Rutherford

• Publisher: Routledge
• Year: 2007
• ISBN:
  9781134160549
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

Written by a well-known author, this book makes a major contribution to the history of financial reporting, exploring the current and international aspects of standard setting.

Compiled through consultation of a considerable amount of relevant literature and interviews with a large number of key players of the ASC, it analyzes the big 'set battles' between standard setters and preparers of financial statements, over topics such as price change accounting, goodwill, and leasing and foreign currency translation, the stand-offs which delayed development in specific areas and the smaller skirmishes which impeded the work of improving financial reporting.

It covers a range of topics, including:

• 
  
  

• the formulation of standards on specific topics
• the evolution of the institutional machinery of standard-setting
• the politics of standard-setting
• the theory of accounting standardization
• the emergence of a conceptual framework for financial reporting.

A fine account of the period following the 1960s, charting the history of the Accounting Standards Committee, this book is an essential resource for business and finance students.

1 ‘Present Troubles, and More to Come’

The President of the Institute of Chartered Accountants in England and Wales in December 1969 was Ronald George Leach.¹ Leach trained with Peat, Marwick, Mitchell & Co., joining the firm at the suggestion of his father, who was a director of the Queen’s coach builders, a client of Peat’s. He qualified in 1932, coming fifth in the honours list, and was to remain with the firm all his working life. He joined the Council of the ICAEW in 1963 and became senior partner of the practice in 1966, the first from outside the Peat family. Together with Sir Henry Benson,² who beat him by one place in the honours list, Leach came to dominate British accountancy; he was considered ‘a titan within the profession’³ and on his death Accountancy mourned ‘the last of the household names’.⁴ Leach and Benson were strong and effective leaders, whose writ ran not only within their own firms but also in Moorgate Place, headquarters of the ICAEW; furthermore, they were accepted by government as speaking for the profession.⁵

On Thursday, 11 December 1969, six months into his term of office, Leach read a ‘Statement of Intent on Accounting Standards in the 1970s’ to the assembled members of the press. It had been prepared from a draft considered by the ICAEW Council on the Wednesday of the previous week.⁶ The press, who had been summoned to the Institute’s headquarters with little warning of the dramatic nature of the announcement,⁷ heard the President say that it was his ‘Council’s intention to advance accounting standards … [by] narrowing the areas of difference and variety in accounting practice’.⁸ The content of the statement, the speed with which it was prepared, and the manner of its announcement, foreshadowed a radical change in the Institute’s stance on the regulation of technical matters. Why did this change come about, and why at this particular juncture?

Most writers describing the creation of the UK’s first machinery for accounting standardization have taken the view that the Council was in the grip of a series of major scandals in the corporate sector, scandals which were exposing serious deficiencies in accounting methods and left little choice but to tighten up regulation in a substantial way. Writing in 1981, for example, Professor Michael Bromwich describes events thus:

In the late 1960s a storm of criticism arose in the UK against the accounting profession’s efforts to set guidelines. Accounting methods had been found wanting in a number of financial debacles that are still notorious today. These included the collapse of Rolls Razor Ltd, in 1964, just after publishing ‘clean’ accounts, and the vast difference between AEI’s profit forecast for 1967 and the large loss reported after its takeover by GEC, partly resulting from the use of different accounting principles. Finally, there was the failure of the Leasco-Pergamon takeover, central to which was the use of different valuation bases for the same items by the two companies.⁹

Twenty years later, the consensus still holds. According to Professor Vivien Beattie, writing in 2002, ‘pressure for reform in the UK came to a head with several public “accounting scandals”, notably the GEC/AEI takeover in 1969’.¹⁰

Those directly involved offer similar accounts. Leach himself argued that ‘it was in fact the development of the takeover bid which limelighted … deficiencies of the system … [T]he accounting bases adopted by the offeror and offeree could be strikingly different. Perhaps the most famous case was the AEI-GEC merger.’¹¹ Since they are so strongly associated with the emergence of accounting standards, it is worth investigating each of the debacles in some detail.

Accounting Scandals

On 28 September 1967, the General Electric Company Limited launched a bid to take over Associated Electrical Industries Limited.¹² This was resisted by the directors of AEI and, in the course of the acrimonious battle that ensued, the AEI Board issued a statement to the effect that the company would earn a profit, for the financial year ending 31 December 1967, of £10 million. Although this was technically a forecast, ten months of the financial year had already elapsed and it was reasonable to assume that there was little uncertainty associated with the figure. The forecast was very similar to the previous year’s result, despite the outturn for the first half of 1967 having been much poorer than that in the equivalent period of 1966. AEI’s optimism surprised outsiders; GEC attacked the forecast strongly and its credibility became a major issue in the closing stages of the contest, which was very close run. GEC’s offer had to be raised twice, by more than 40 per cent in total, and favourable votes did not reach a majority until the opening of the post on the morning after the voting deadline.

GEC’s financial year-end was 31 March and the company treated the whole of AEI’s results for 1967 as pre-acquisition to the group. Nonetheless, GEC chose to put the AEI figures firmly in the spotlight: they were announced at the same time as the group’s results and showed that AEI had made a loss of £4.5 million, a, now-famous, gap between forecast and outturn of £14.5 million – the equivalent at current prices would be in the order of £170 million.

GEC commissioned a report on the discrepancy from the joint auditors of AEI, Deloitte, Plender, Griffiths & Co. and Price Waterhouse & Co., and this was published on the same date as the results, 29 July 1968.¹³ The report began by pointing out that the size of the discrepancy had to be viewed in the context of a value for stock and unbilled balances of work in progress of some £100 million and continued:

The appraisal of stocks, contracts and a number of other matters involve the exercise of judgement; they are not matters of precision. Broadly speaking, of the total shortfall of £14.5 million we would attribute roughly £5 million to adverse differences which are matters substantially of fact rather than of judgement and the balance of some £9.5 million to adjustments which remain matters substantially of judgement.¹⁴

The amount of the shortfall attributable to operating divisions was £13.8 million, 95 per cent of the total, and the report gave a breakdown of this figure by type of adjustment. Although the amounts do not line up exactly, the total for three items, additional provisions for stock obsolescence, losses on contracts in progress and completed, and bad debts, which would appear to qualify as matters of judgement, stands at £9.2 million and is fairly close to the figure attributed to judgement in the paragraph quoted above. Most of the remainder arose from the estimation of cost of sales in the forecast, which would be likely to involve matters substantially of fact.

Thus, on the basis of the public record at the time, it appears likely that the judgement involved related to future outcomes rather than the appropriateness of accounting methods. This interpretation has since been lent considerable support by the publication of extracts from the Price Waterhouse Partners’ Newsletter in Edgar Jones’ history of the firm: the issue of 6 August 1968 assured partners that the difference was not due to a change in ‘method’, but rather to ‘the assessment of net realizable value in relation to substantial stocks and incomplete contracts, without any departure from the basic accounting principle’.¹⁵

Whether the two sets of judgements were reasonable in their different circumstances became a matter of heated dispute. Given the circumstances, it would not be unreasonable to assume a degree of optimism, not necessarily by any means reckless, in the AEI forecast. Equally, GEC would have been likely to take a pessimistic view; its approach to the routine estimation of provisions in its own financial statements was well known to be strongly conservative¹⁶ and it had begun reorganizing AEI’s business immediately after the takeover,¹⁷ so that there would certainly have been some change in management intentions underlying the necessary judgements. Whatever the truth of the matter, no major issue of accounting method appears to have been involved.

Within eleven months of the disclosure of the AEI-GEC gap, events which were to result in a second scandal were set in train, again by a takeover bid. The Pergamon-Leasco affair was to become a much longer-running business and had all the complexity commonly associated with the activities of the late Robert Maxwell.¹⁸ Maxwell had built up Pergamon Press Limited by applying aggressive business techniques to the traditionally staid world of academic publishing. For example, he developed a stable of highly specialized scientific journals charging high prices for subscriptions, which would be taken out mainly by university libraries following the instructions of academics seeking to publish in the same journals.

Maxwell’s success was greatly admired in the City and when he took the company onto the stock market, its shares proved popular.¹⁹ However, by 1969, he was keen that Pergamon, in which he had retained a substantial stake, should be taken over. He approached the Leasco Data Processing Equipment Corporation of New York, in fact a conglomerate, headed by Saul Steinberg. After lengthy negotiations, it was agreed that Leasco would buy the entire share capital of Pergamon. Under the agreement, announced on 18 June 1969, independent shareholders were offered loan stock or cash and the Maxwell interests would accept stock for 25 per cent of Pergamon’s capital and cash for their remaining 9 per cent. However, it transpired that Maxwell had not cleared the deal with the trustees of some of his family interests, who wanted cash for all their holdings, and further negotiations became necessary.²⁰

During the delay, Touche, Ross, Bailey & Smart, called in by Leasco as investigating accountants after reaching the original agreement,²¹ expressed doubts about the position of a Pergamon subsidiary, the International Learning Systems Corporation, and about trading relations between Pergamon and Maxwell Scientific Inc. (a Maxwell family company).²² Leasco had been buying Pergamon shares on the open market at below the cash price agreed for the deal and on 20 August discovered that some of these had come from Maxwell family interests that it had been told were committed to the deal. It thus found that it had achieved a lower percentage of support than it had supposed and had been paying cash for shares it thought it was to obtain for stock.

The failure to disclose dealings by family interests breached the City Code on Takeovers and Mergers.²³ The following day, Leasco announced that it would not be proceeding further, giving as its reasons the doubts expressed by its investigating accountants and concerns about the published forecast earnings of Pergamon for 1969. Leasco was obliged to defend its withdrawal to the City Panel on Takeovers and Mergers, which accepted its explanation and referred the matter to the Board of Trade.²⁴ In September 1969, the Board of Trade appointed Companies Act inspectors to investigate; one of the two inspectors was Ronald Leach.²⁵

A second inquiry, also established in September 1969, is of more interest here. Leasco agreed a new deal under which it would pay cash for all outstanding shares in Pergamon on the basis of a multiple of average earnings for 1968 and 1969. To determine earnings for the purpose of fixing the price, the Board of Pergamon appointed Price Waterhouse & Co. to review the company’s financial statements, already published, for the year ended 31 December 1968, and the half year statements to be produced for the period to 30 June, 1969 – the latter period was subsequently extended to nine months.²⁶ The firm was to report ‘any changes in accounting principles … consider[ed] advisable’, ‘any substantial adjustments … consider[ed] appropriate’, and ‘what additional information might … be given to … shareholders’.²⁷

As well as involving complex arrangements, the Pergamon-Leasco affair resembled other chapters of the Maxwell saga in the elaborate web of litigation that surrounded events. Maxwell appealed against the Takeover Panel’s decision and successfully delayed the publication of the Board of Trade inspectors’ report, taking the latter case to the House of Lords.²⁸ Leasco brought actions against MSI which, in turn, MSI used as a basis for refusing to disclose information to Price Waterhouse, despite Maxwell having confirmed in writing that he and his family trusts would cooperate with the inquiry unconditionally.²⁹

Price Waterhouse conducted the bulk of their initial inquiries in November 1969³⁰ and provided an interim report, dealing only with the 1968 accounts, in March 1970. Their final report was published on 21 August 1970. Its length reflected the complexity of the affair: summaries occupied eight pages in Accountancy³¹ and six in The Accountant’s Magazine.³² The recommended adjustments reduced trading profit for 1968 by £1.6 million (some £18 million at current prices and 76 per cent of the previously published figure). The company incorporated the recommendations in relation to the 1969 accounts in the published financial statements; as a result, trading profit for the first nine months of 1969 stood at a mere £29,000.

It will be recalled that Price Waterhouse was asked, among other things, ‘to report any changes in accounting principles which [it] consider[ed...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright Page
• Dedication
• Table of Contents
• List of Tables
• Preface
• Series Editor’s Foreword
• Acknowledgements
• List of Abbreviations
• 1 ‘Present Troubles, and More to Come’
• 2 The Invention of the Accounting Standard
• 3 Honeymoon Period: 1970–1974
• 4 Accounting for Changing Prices: The Struggle Begins
• 5 The Holy Grail
• 6 The Going Gets Tougher: 1975–1979
• 7 Reforming the System
• 8 The Art of the Possible: 1980–1984
• 9 Accounting for Changing Prices: The Struggle Continues – and Ends Badly
• 10 Losing Steam? 1985–1990
• 11 Setting Accounting Standards 1969–1990: Technical and Political Realms
• Notes
• Appendices
• Bibliography
• Index