Call for review of equity accounting

Press, 18 March 1985, Page 33

Call for review of equity accounting

The practice of equity accounting by companies should be reviewed, according to the chairman of the Securities Commission, Mr Colin Patterson. Speaking at the Society of Accountants convention in Christchurch on Friday, Mr Patterson said that the profit and loss accounts of the investing company should include only the dividends declared by the associated company. The balance sheet of the investing company should disclose investment in other companies at valuation, with a note to explain the historical cost and the basis of valuation. Equity accounting is a mechanism whereby a company which holds a substantial interest (in the order of 20 per cent) in another and is in a position to “exercise significant influence” over the associate may include part of the associate’s assets and profits in its own accounts. Mr Patterson said he believed that, as it was originally conceived, the practice of equity accounting was intended to be confined to associations in the nature of partnerships or joint ven-

tures in which the right of each partner to call for a distribution would have been established by contract or at least by common understanding. “The practice has now been extended, however, to virtually all cases in which an investing company holds a 20 per cent interest,” he said. “There can be no doubt that the willingness of New Zealand listed public companies to invest in the shares of each other has been stimulated by this practice. “I have grave reservations about it because I believe the rationale for the practice is contrary to the present law. “The practice assumes that one company can assert a significant influence on the affairs of another company, especially through the appointment of a representative or nominee director. “If there is one principle of company law that is unquestionable it is that the directors of a company must act in its interests and must prefer its interests whenever they are in conflict with anything else. “The idea that a director

can act as a representative or nominee of another company, unless he is so authorised by the articles, is I believe in conflict with that principle. “Nevertheless, the practice is well established and we constantly see reports in the financial press to the effect that an investing company has representatives on the board of another company. “Perhaps it is the law that needs to be changed, though I prefer to think that the law is sound and that the practice is questionable.” Mr Patterson said the accounting standard covering equity accounting was being reviewed by the Society of Accountants and he had taken steps to ensure, the review would give consideration to his proposals on profit accounts and balance sheets. He said a particular accounting difficulty arose when there were cross shareholdings and circular shareholdings. He favoured the view that the capital of each company should be regarded as being reduced by the common amount in each shareholding.