It's OK, it's in Writing: Ethics in the Balance Sheet

John Henry Thornber

31/10/02

The recent spate of company closures which has brought to public attention the loss, not only for creditors, but also employees, for outstanding payments, raises questions about how well uncashed provisions reflect the true position of an organisation in terms of the capacity to meet its obligations.

Long Service Leave provides a particular case.

What duty is there on any organisation to ensure that the legal requirements for payment can be met?

Should an organisation be deemed insolvent if it cannot pay out these legal requirements at any time, rather than stating, with a wave of the hand, that the debts are covered?

How realistic is the valuation of the assets in an Auditor’s Report? Can employees take from the statement with confidence that all their entitlements are covered? If not, do they have redress against the auditor in the event of failure? Case law shows that institutions such as banks may not rely on Auditor's Reports as they have access to other sources of information. But do those who have only the Reports to rely on have a right to expect that the information is valid?

Clearly, having Long Service Leave as an unfunded Balance Sheet Provision is not satisfactory when, at time of closure, the figures continually given for assets in the Balance Sheet cannot be realised.

Nor can the likely suspects be identified, as is recognised by the Benfield Greig Report on a National Insurance Scheme to Protect Employee Entitlements: Preliminary Feasibility Study to the New South Wales Government in 1999:

"We would strongly recommend that any scheme to protect employee entitlements should make it compulsory for employers to insure. In saying this it is recognised that "good" employers will, in one sense, be cross-subsidising "bad" employers but the categorisation of which employer is solvent or insolvent is a concept valid only at a single point in time.

The claims are made that funding these provisions is leaving cash idle.

Such a claim reflects the giving of advantage to one group over another. It makes the claims for "the best possible returns for shareholders" a priority which does not always acknowledge the legal and ethical requirements which are created by other priorities that need attention.

The unspoken value of the demand for the immediate "as best possible return" is also a position which becomes the framework (and eventually for society's modus operandi, the only imaginable framework) from which the Balance Sheet Reports are created. Only in this world, this framework, it becomes believed, can business operate.

Not surprisingly, the quotation from the Benfield Greig Report above assumes such a framework. Its advice is built on a framework of insuring against something going wrong rather than a framework of meeting legal obligations internally in a financially prudent way.

This framework leads to strategies of operating on a low cash level, or overdraft. Is that not a mindset of "how we must"? If the expected framework allowed for the cashing up of requirements, it would no doubt alter many priorities and practices of employees as well as employers.

The Long Service Leave Act, 1955 (in New South Wales) exists because of a specific call for increased time for the refreshment of workers. Its framework imagined that employees needed the opportunity for rejuvenation. Well before its time, it should be seen as a promotion of health and well being.

Currently that framework (and imagination) is under threat from several quarters.

The developing framework for conducting business is that pressure of work means that many employers and employees cannot imagine space for such leave. There seems to be, as a corollary, an increasing rise in courses on stress management (to keep healthy), but no effort to use the leave created for the very purpose in a time when stress was hardly thought of.

Why would businesses prefer to pay increased workers compensation premiums for stress claims than either encouraging the taking of long service leave or ensuring its funding?

There is a call to keep working because of an imagined indispensability which sees people involved for longer hours in a manner that makes the drive from the protestant ethic pale into insignificance.

Employee practices then play a part in distortion. Many employees now imagine their Long Service Leave entitlement as a nest egg for retirement and seek to accumulate it rather than use it for the intended purpose.

This further complicates the cycle, as employers, in complying with this request, are then bound to pay the total amount of leave at the higher rate. This in itself adds to organisational costs.

Beyond that, if there is a failure of the company, the employee is aggrieved for being even further out of pocket for funds that should have been taken many years before.

Often, employers have entered into this mesh by imagining that they "can’t afford" to have an employee take the leave.

Pragmatically, the recent cases have led to calls for employer levies, the setting up of trust fund, or an insurance scheme to protect employee entitlements.

Benfield Greig estimates the annual cost of covering all entitlements at between .1% and .3% of salaries, with evidence that, in Spain in recession, 1% was needed.

One would ask what is the difference, in effect, between a compulsory levy or insurance requirement of 1% of wages, and a prudent managerial position of funding a provision at 1%, of wages which, if properly managed, might be expected to provide a substantial level of self-funding?

Given that it is a required commitment to a future period, perhaps the taxation arrangements for the fund might be addressed so that efforts to meet a legal requirement are not made more difficult by being continually taxed.

There seems an oddity in a government’s willingness to wield a new big stick when action could be taken within existing structures.

The extent of the oddity is reflected in the Benfield Greig Report which outlines an elaborate insurance scheme (linked to the Workers Compensation Insurance Scheme) and the perceived pitfalls which could arise.

If the Government felt the need to take action, it would seem more reasonable to introduce the power to check that Long Service Leave Provisions are adequately funded rather than introduce a wholesale administrative structure with compulsory contributions to an insurance scheme. Administration of the scheme is estimated by Benfield Greig at 6.5% and Claims Management at 9.6%.

It could be expected that such costs of administration would be much higher than having the auditor note and report that the Provision is funded.

The Report even speaks of the need for the Government to be the insurer of last resort to make the insurance scheme attractive (therefore profitable) to private insurers. So rather than protecting employees, the Government is called on to protect insurers.

Some employers oppose any imposition. Yet how sure is any employer that the sale of assets would see all debts covered? Or is failure unimaginable? If debts are not covered, on what ethical value is the Balance Sheet built?

The implications of Long Service Leave for organisations vary. Some may have to replace staff members who are on leave, others have the flexibility to leave the position unfilled. If staff turnover is rapid, the need for provision is low.

In Catholic education in Australia, where the individual Dioceses and independent schools are separate employers in law, several employers have agreed to make Long Service Leave portable across their sectors. This is done as an encouragement for teachers to look to other employment opportunities as part of their own development.

The implication is that the LSL Provisions have to be substantially funded, as the agreements require the forwarding on of funds when a teacher changes from one employer to another under the scheme. Practically, this needs to be done.

It would seem unjust to require this sector to pay the additional costs of the insurance scheme suggested by Benfield Greig.

One major organisation paid dividends of $120 million in 1997. It listed Employee Entitlements at $297.4 million. In the same year, the New South Wales Health Department's Report listed Employee Entitlements at $71.6 million. The vastness of the sums in these examples indicates the seriousness of the reality.

The ethical question arises because of the way the world is imagined. As a result, a significant law, with great potential for well being of both employees and the balance sheet, perhaps needs more attention. In the long run, shareholders should also expect to benefit from a revisit with a fresh look at its possibilities.