Thursday, March 27, 2008

Rules trump principles ... and the result is disastrous

Dear Colleagues

Accountancy has been in professional free-fall for a long time ... especially in the United States.

In large part the professional failures of accountancy in the United States have resulted from a legalistic approach to accountancy. In the USA, the legal rules and regulations have more importance than the fundamental principles of accounting. In this arrangement it is easy for a law or rule to be make an accounting treatment legally acceptable when the principles of accountancy would argue that it is absolutely wrong.

About 50 years ago, the Institute of Chartered Accountants in England and Wales (ICAEW) argued for a renewal of its Royal Charter precisely because of this issue ... the principles of accountancy should not be able to be over-ridden by law that has no duty to following accountancy principles. The ICAEW prevailed and there was a new Royal Charter.

But the United States has a different professional framework ... and the rules of accountancy, and laws, are more important than principles. Over the past several decades the rules and the laws have moved more and more to allow accounting practices that are anathama to anyone who has a commitment to the basic fundamentals of accountancy.

The following is an example of accountancy that has lost of sense of its role and its responsibility:

New Century Publishes Gain on Sale White Paper
IRVINE, Calif., May 7 /PRNewswire/ -- New Century Financial Corporation (Nasdaq: NCEN) announced today it has published its "Gain on Sale" white paper, authored by Edward F. Gotschall, Vice Chairman and Chief Financial Officer, on its Website ( This paper provides an in-depth review and explanation of certain gain on sale accounting issues confronted by companies in the specialty finance sector.
"We are very pleased to have Ed Gotschall articulate the very complex issues of gain on sale accounting faced by the issuers of financial reports and the investors / analysts who are required to make informed investment decisions on our stock," said Robert K. Cole, Chairman and Chief Executive Officer. "Ed's done a great job of providing a common basis to understand and compare assumptions used to record gain on sale, and a method by which to evaluate actual results. We believe that the increased detail of financial information presented in our recent first quarter 1998 earnings release and the Gain on Sale white paper should guide investors to be better informed and more confident in their investment decisions."
"We invite you to read the gain on sale article located on the analyst page of our Website and hope that it will provide you with a better understanding of these accounting issues," added Cole.
New Century Financial Corporation is a specialty finance company that originates, purchases, sells, and services subprime mortgage loans secured primarily by first mortgages on single-family residences.
The concepts described in this paper sound like they are absolutely and totally unacceptable under the accountancy principles that prevailed when I was studying accountancy prior to qualifying. My guess is that the prevailing law and the rules of accountancy allow this ... but it is neither good accountancy nor is it correct accountancy.

New Century Financial Corporation became one of the first casualties of the sub-prime mortgage melt-down ... and now the questions are starting.

It will be interesting to see who gets the blame. According to recent articles it appears that KPMG will get its fair share of criticism ... but the problem is deeper than this firm alone. There is a systemic problem that includes not only the accountancy profession but also the role of law and lawyers as well. There are many fundamental issues of society that need to be put on the table and resolved.

Society ... and people ... are not being well served by our professional classes.


Peter Burgess

No comments: