The influence of pressure groups on financial statements in britain

Professor Ijiri expresses a popular viewpoint when he states that the data provided by accountants ‘directly affect the way in which conflicting interests are solved’.1 This paper suggests that there is also a flow of influence in the opposite direction: the development of data is affected by the conflicting interests of its suppliers (management), its consumers (mainly shareholders and creditors), regulatory agencies and accounting bodies. Accordingly, their changing interests are reflected in the changing interpretation of the auditor’s role, i.e., of what is meant by a ‘fair’ view of a ‘company’s affairs’. The main references are the memoranda submitted to, and the reports of, the Company Law Committees in Britain since 1841. The early joint-stock companies, which existed in Britain as far back as 1553,2 rarely communicated formal financial information to external parties.3 Such information was relatively unimportant in the typical company since ownership and control were combined. Creditors, knowing the firm’s owners and relying on the principle of unlimited liability, accepted informal, unaudited financial information.4 Loans were often obtained from intimate business acquaintances, relatives or friends who recognized and trusted the ability and integrity of the owner-managers.5 The early companies were controlled mainly by other mechanisms: maintenance of certain partnership principles (untransferable shares and unlimited liability), direct control by shareholders, and state control.6 The last involved comprehensive investigations by parliamentary committees on petition from proprietors and creditors.7 The formal separation of ownership from management seems to have originated in closely-owned concerns. The information needs of these shareholders were easily satisfied, as they could find out personally how their companies were really faring.8 They usually had some knowledge of the industry; however, as an additional control device, the managers were encouraged to hold a large equity in the company.9 The increasing growth of companies toward the middle of the nineteenth century resulted in the passage of the Companies Act of 1844 to protect the interests of various business groups.10 The contents of the Act were recommended by the Select Committee on Joint-Stock Companies. The evidence presented to the committee by shareholders and creditors of various companies indicated that the special acts (under which companies were incorporated before 1844) generally protected the directors and managers at the expense of the shareholders, and that the shareholders had a great deal of difficulty in getting any knowledge of the state of affairs of the company. It was argued that directors assumed to themselves a power which probably neither their deeds of settlement nor their Acts gave them.11 The 1844 Act required balance sheets to be examined by auditors, and auditors to report ‘whether in their opinion the balance sheet is full and fair… and… exhibits a true and correct view of the company’s affairs’.12 The balance sheet had to show ‘a true statement of the capital stock, credits and property of every description belonging to the company, and the debts due by the company at the date of making such balance sheet, and a distinct view of the profit and loss which shall have arisen on the transactions of the company… '.13 The 1844 Act defined a company as having a capital divided into freely transferable shares; the principle of limited liability was not added until 1856.14 It is interesting, however, that auditing was no longer made compulsory under the 1856 Companies Act. This shift in law is explained by Robert Lowe: ‘having given them [the limited companies] a pattern the state leaves them to manage their own affairs and has no desire to force on these little republics any particular constitution’.15 But the years following the 1856 Act were characterized by speculative ‘manias’.16 Investments again became active in 1863-5, centring around financial, banking, insurance and hotel companies; but then came ‘Black Friday’, 11 May 1866. Of 75 electrical public companies formed between 1881 and 1883, 32 were dead within three years and 36 within five years.17 During the later Victorian period (1870-1900), the capital markets were widened18 but the shareholders’ legal position was weakened. The proprietary interests of shareholders extended only to the receipt of dividends and the return of their capital in case of liquidation.19 Consequently, shareholders began exerting substantial pressure for audited financial information. On the other hand, management attempted to justify secrecy in the name of maintaining the credit status of the company. It defended non-disclosure of detailed information as being in the interests of the shareholders themselves.20 Unsuccessful attempts to introduce compulsory auditing and disclosure of information were made frequently.21 Finally, under the increasing pressures for audited financial information and the increasing intervention of the Government in economic affairs,22 auditing was again made obligatory for joint-stock companies under the 1900 Companies Act.23 By the end of the nineteenth century, the fields in which the company form of organization was used included all branches of the economy.24 Although the present accounting techniques are essentially the product of the second half of the nineteenth century, attributed to the growth of joint-stock companies,25 the 1900 Companies Act does not reflect them. It only requires that balance sheets include details concerning shares issued, and the debts payable in respect of all mortgages and charges which require registration under the Act.26 The Departmental (Law) Committee of 1895 did suggest that such details as the valuation basis of assets and depreciation provisions be disclosed27 but the legislators of the 1900 Act did not accept these suggestions. Demands for such disclosure were made by the London Stock Exchange representative.28 He argued that the valuation of assets on the basis of cost would substantially mislead shareholders.29 But Mr F. Whinney, a member of the Institute of Chartered Accountants (ICA) strongly supported ‘historical’ valuation of assets.30 Mr Whinney, an eminent accountant, had been elected for four terms as president of the ICA.31 The Institute of Chartered Accountants in England and Wales, the largest association of accountants in Britain, was established in 1880; by 1890, it was already ‘important commercially and held in respect by Government officials’.32 Even then, the council of the ICA ‘felt it to be imperative to keep watch over legislation affecting commercial interests, and showed increasing activity in tendering advice’.33 The opinion of the ICA had apparently even more influence on the legislators of the 1900 Act than did the recommendations of the Departmental Committee of 1895. The latter body, appointed by the Board of Trade to review the Companies Act, had included ‘experienced accountants’34 such as E. Waterhouse, former president of the ICA. Some of its recommendations were based on the suggestions of Mr F. Whinney, who joined the London Chamber of Commerce in urging that ‘the auditors should certify whether the books have been properly kept’, in addition to expressing their opinion on whether the financial statements reflect a fair view of the company’s affairs ‘as shown by the books of the company’.35 This suggestion was accepted by the Committee, which emphasized that it had been approved by its accountant members.36 But the ICA objected, and suggested the omission of the words ‘have been properly kept’. It added that ‘the auditor is only called in at the end of the period and it is not part of his duty to supervise the bookkeeping of the company… '.37 Another of the committee’s suggestions was that auditors be required to report whether the balance sheet had been drawn up ‘in accordance with the provisions of the Act’.38 This was also opposed by the ICA, because ‘differences of opinion between directors and auditors are not uncommon, and in such cases the provision of the Act would throw a great and onerous additional responsibility on the auditors’.39 This demonstrates the conflicts within the elite of auditors at that time.