When I came out of public practice and went to work for a business in their Finance team, I was fairly naïve. I still had a very black and white view – an auditors view – of accounting. And so, some of the practices of the management accountants were a real shock to me.
My point in this article is that they should be a shock! Finance professionals in business are supposed to tell it how it is and to be the ones that keep the business honest.
There’s a general joke about the term, “creative accounting” (it’s supposed to be an oxymoron!) But if we’re honest with ourselves in Finance, much of that practice happens with the intention of misleading people. And the only reason we don’t call it fraud is that these things normally involve judgment, and therefore we can justify it as just being “very prudent”.
Accruals and provisions
In that first job outside public practice, one of the most shocking things to me was the way they used accruals. On two counts…
Firstly, like many other Finance teams, we had the practice of sending a form to cost centre managers at the month-end to ask them for details of how much their accruals were.
The Marketing team were very switched on, and their neatly and timely accrual form submission was always impressive.
But over a few months, I realised that very few of the accruals on the Marketing form actually related to real expected costs. I asked time and again when they were expecting to get invoices for things on the list, but they never came.
The Marketing Director had come to see accruals as a way of smoothing monthly expenditure and matching it to their budget, to avoid questions. He also discovered that it ensured that he kept his budget when it came to the “use it or lose it” time of year.
The second example was one I really objected to at the time. One month we’d had a really good month. And we took the final accounts to the Managing Director for review as usual. And he looked at it, asked a few questions, and then told us to “put aside another £200k – I don’t care where from” – before we submitted the numbers to Group.
I mean, I really thought he’d just be happy with the result! But he wanted to make it deliberately worse? With no explanation?
That was my first exposure to “sandbagging” – when things are going well against the budget, make it look not quite as good so that you have something up your sleeve when things aren’t going so well.
I complained to the Finance Director about having to do it, saying it was just wrong. He told me that I was taking a “very auditor view” and that this practice was “commercial reality” and I ought to get used to it.
In both cases, they may have got them past the auditors, but they were done with the intention of misleading someone. And Finance was seen as facilitating that.
When sandbagging is good
A few years later, I was the Finance Director of the same business, but under different ownership.
And then I realised the problem with the straightforward, honest, approach. I continually had to stand up in Board meetings and explain that part of the P&L was wrong because of errors one month, and the correction of errors the next month. That, frankly, just makes you look stupid when that happens. It undermines the confidence of the management team, and Group Finance, in what you do. And it’s never right either!
So, I started sandbagging where I could!
BUT, I had a rationale. I was not just saying, “put aside another £200k” with no foundation.
The problem was the unreliability of the data we were using for distribution cost accruals. It wasn’t possible to get accurate data on working day 3 when we needed to capture it. So, I told the management accountant to fix the monthly distribution cost as a percentage of sales, based on the monthly average of the actual invoices over the previous 3 months, and accrue or release provisions to get to the right answer. Then we’d review and smooth out the accrual balance every few months.
Basically, I smoothed the errors.
There was no intention to mislead. It was just a practical way to make monthly accounts look sensible when there was no way of being 100% accurate.
Capitalising stuff you shouldn’t
The other classic way to intentionally mislead is to capitalise expenditure when it doesn’t strictly fit the definitions in IAS16 or IAS38. Especially the latter when it comes to software development projects.
This takes place in very P&L focused organisations, where there’s a P&L budget but they don’t really monitor against a CapEx (capital expenditure) budget.
Where I saw pressure from the business to try and manipulate this was from project sponsors in a big group.
On one hand, if they were trying to get their project into the budget for next year, they would assume that a lot of the costs could be capitalised so that their budget submission would be more likely to be signed off.
On the other hand, they’d attempt to actually capitalise as much as possible just to stay within the year-to-date budget – even if their total forecast costs were on target – just to avoid questions.
You know the kind of story. I bet you’ve got loads of examples of your own – do comment below if you’ve seen particularly bizarre examples.
What makes it all wrong
The practices that I still strongly believe are wrong are the ones designed to be deliberately misleading for the purposes of self-interest. You don’t want to lose your budget – don’t use accruals to protect it! You don’t want to get beaten in a Board meeting for bad performance – don’t use accruals to protect you! You want your project to go ahead – don’t use capitalisation policy to help your case!
As I said above, smoothing is something I can now accept, so long as it is linked to actual results – I wouldn’t even try and hide this from the auditors. But being deliberately misleading is not ok.
And the thing that makes it ‘not ok’ is that it makes us lie to ourselves. Let me give you an illustration.
I’m trying to lose weight, and I have an app called ‘Lose It!’ that tracks how much weight I’m losing and how many calories I’m taking in each day. It gives me a calorie budget for each day, which varies depending on how much weight I’ve lost, how many calories I’ve consumed this week, and what my targets are.
What I sometimes find funny is that when I stand on the scales and I don’t like the number that comes up, it actually crosses my mind to enter a different number in the Lose It! app so that I feel better about my progress. How stupid is that?! I’d lie to myself, even though I know I’m doing it! Why not just accept the volatility of the measurements?
Also, when I know I’ve eaten too much of the wrong food I actually consider not recording it in the app with all the relevant calories because it makes me feel bad! Why would I do that if I know it’s not true?!
Deliberately recording erroneous information doesn’t help anyone. I need the truth to help me lose weight. Kidding myself is not going to help.
Likewise, the business looks to Finance to provide the truth about the performance of the business – not just what the Exec wants to hear, not just what Group wants to hear, not just what the shareholders want to hear. It’s our job to give them that objective assessment of performance. We’re not just there to help our management colleagues circumvent controls and reviews to do what they want.
If Finance doesn’t deal in facts, truth and honesty in the business, who will?
One final observation
If you were to do a word search in the paragraphs above, one word would come up as implicated in every intention to mislead.
That word is ‘budget’!
One of the big problems with business budgeting, as many people have documented, is that it leads to “gamification”. It leads to behaviour that isn’t positive for the business.
Could we get back to more honest performance measurement if we did something about budgeting?
The point I really want you to take away and think about is the extent to which you, as a Finance professional, are contributing to the business lying to itself, and lying to its owners, intentionally and with executive self-interest.
Because my belief, even 21 years after my initial culture shock, is still that accountants should tell the truth and be objective, even if the business doesn’t like the result.
Sometimes we need to remember that we work for the owners of the business, ultimately, and not just the management. Our job is to do the best for business performance for the owners. And that means not lying to them about performance, and not allowing the Exec team to do so.
The business may joke about us being ‘bean counters’, straight-laced and boring. But deep down, it’s the boring dependability that they really like, want, and need, from us. They turn to us – as business partners – because they know we will tell them the truth, that we’ll be honest, and we’ll tell it straight.
And we’d rather be having conversations with them about how we can – together – improve business performance, rather than spending time working out how to ‘cook the books’!