Associate Professor Mark Bunting (BSc(Inf Proc), HDipAcc, MCom(Rhodes), CA(SA), MIFM, ACA (ICAEW))

Mark has recently returned to the Department after spending 2008 and most of 2009 working at the International Accounting Standards Board in London.  The IASB is the organisation that establishes the accounting principles in terms of which companies in more than 100 countries, including South Africa, report their financial performance.  Mark describes his time with the IASB as highly informative and says that he is greatly looking forward to applying the knowledge and experience he has gained in his research and teaching work at Rhodes.

Mark is now mainly involved in academic research, but he also lectures senior undergraduate and postgraduate financial accounting and financial management. In addition, he keeps his book "Financial Reporting in South Africa" up to date with annual revisions.

Mark's current research interests lie in two areas:

Fair value accounting and pro-cyclicality

The current global financial crisis has raised questions about the fitness for purpose of fair value accounting, in terms of which financial instruments (and a number of other asset classes) are recorded at the amount for which an asset could be exchanged between knowledgeable, willing parties in an arm's length transaction. A great deal of controversy has arisen from this seemingly innocuous proposition. Fair value accounting (also known as mark-to-market accounting) currently faces challenges from legislators, banks, investment managers and others, on the basis that it has pro-cyclical effects.

In terms of this argument, fair value accounting may indeed work well in the context of fully functioning, liquid and efficient markets, but when this functionality breaks down, significant problems are inevitable. Reporting assets at fair value with reference to distressed conditions in financial markets, it is argued, exacerbates market panic and illiquidity, which results in further losses. In this way, conditions of market distress are worsened, and can become entrenched. In other words, fair value accounting stands accused of causing a negative feedback loop.

The resulting debate between legislators and accounting standard-setters has centred on such issues as the acceptability of allowing reporting entities to stop fair valuing financial assets under distressed market conditions, or allowing losses from fair value reductions to be recorded outside the earnings numbers that are tracked by analysts.

It has been a fascinating exercise over the past year or so to observe the game of transatlantic political tit-for-tat that has transpired between the US Congress and the Financial Accounting Standards Board on the one hand, and the European Commission and the International Accounting Standards Board on the other. Typically, the FASB is pressured by Congress to make specific allowances in respect of accounting for fair value losses. The EC takes note, worries that European banks are being put at a competitive disadvantage, and demands similar relief from the IASB. This process has also happened in the reverse direction, in what has been described as a race to the bottom for global accounting standards.

To make matters worse, people in other jurisdictions who also use the IASB's standards are deeply angered that the EC appears to be treating the IASB as a personal fiefdom (and that the IASB is giving in to EC demands), when the standards involved are meant to have global, rather than merely European, applicability.

It is, however, neither the political nor the normative aspects of the fair value controversy that holds an interest for Mark. Rather, he wishes to contribute to the debate by means of positive research, in particular by testing empirically whether fair value accounting has driven movements in financial markets, or merely reflected them.

Recurrent financial crises and repetitive standard-setting failure

The second line of research interest that Mark is following relates to the recurrent nature of financial failures. To illustrate this point, Brown (2005: 20) notes that "the failure of fundamental US financial processes, checkpoints, and institutions has been staggering and on such a scale as to be difficult to fully absorb". This could easily be a reference to current conditions, but it is not: instead, it is an extract from a paper that discusses the failure of Enron in late 2001.

There are a number of startling similarities between the accounting constructs that were employed by Enron and the accounting problems currently surfacing in the most recent financial crisis. Apart from abuses of fair value accounting, Enron is particularly infamous for its use of
securitisation by means of so-called special purposes entities (SPEs). SPEs are structures that are legally separate from the parent entity. Properly used, they can be employed to perform specialised functions, assist with cash flow management, or isolate and transfer financial risks. Enron used them to hide its massive debts, and it was able to do so as a result of the
FASB's accounting rules that were then applicable.

At the time, the IASB congratulated itself on having the superior set of accounting standards: "international accounting rules on SPEs, as laid out by the IASB, are tougher and would, if applied properly, have forced Enron and its auditors to include them in the firm's accounts" (Economist, 2002). Embarrassingly, however, less than six years later the securitisation of
subprime mortgages and the related use of unconsolidated SPEs turned out to be highly significant aspects of the current financial crisis, and the IASB has been obliged to add an urgent review of accounting for SPEs to its research agenda.

This is just one example of a system of accounting standard-setting that, according to Clark and Dean (2007: 95) produces financial statements that are "mere artefacts of the processing rules imposed on accountants through the compulsory imposition of accounting standards. Some of the data are pure fiction. They are not merely unrepresentative of what they describe, they have nothing to describe". The Economist (2002) refers to accounting as being "broken". A senior inductee into the Ohio Accounting Hall of Fame describes his career as a failure because "accounting is very nearly the same in my end as it was in my beginning - what is being put in accountants' minds [in the current texts are] the same useless concepts, invalid claims and senseless numerals that I studied in my first accounting class circa 1952" (Sterling, R, 2006 in Clark and Dean, 2007: 66).

Mark wishes to contribute to the debate on why accounting standard-setters repeatedly fail to prevent the accounting practices that either directly cause, or significantly contribute to, financial crises. Because of what may be described as the evolutionary dysfunctionality of accounting standard-setting, new accounting standards are often regarded as being ineffectual (or even wrong), or as having arrived too late. It is a situation that brings to mind the apocryphal general, highly prepared for the last war, but hopelessly unready to fight the next one.

References

Brown, RE, 2005. Enron / Andersen: crisis in US accounting and lessons for government. Public Budgeting and Finance, Vol. 25, No. 3, pp 20 - 32.
Clark, F and Dean, G, 2007. Indecent disclosure: gilding the corporate
lily. Melbourne: Cambridge University Press.
The Economist, 2002. The trouble with accounting: when the numbers don't
add up [online]. Available by subscription:
http://www.economist.com/business/displaystory.cfm?story_id=E1_JSVRQS.