Early in September, less than two weeks into his intermediate class, Paul Miller received this e-mail message from one of his students:

Hello Mr. Miller,

I have a dilemma. I've been in the accounting field for a number of years and never once gave thought to whether or not I was acting ethically until I came to your class.

You knocked my socks off when you said that [generally accepted accounting principles were] politically contrived. I had no idea that GAAP was not carved in stone. But I am really confused. Are you saying that the principles change? And if the principles change, how do you know if you're acting ethically or not?

Hopefully, I just went off in the wrong direction here, and you can help me straighten this out.


This student's reaction started us thinking that others out there within the reach of this column may be operating under the same misconception that generally accepted accounting principles are rock-solid, conceptually-based, time-tested guides for producing financial information that meets the capital markets' needs. If so, we would be remiss if we didn't confront them with the same facts and ideas that brought Paul's student to her accounting epiphany.

According to our dictionary, an epiphany is "a sudden intuitive leap of understanding through an ordinary but striking occurrence." Other epiphanies that come to mind include the "Eureka!" cried out by Archimedes when he got in the tub; Newton's purported encounter with a falling apple; and Saint Paul on the road to Damascus. Epiphanies are seldom welcomed by those who are in power because, as another student of ours once said, "Change is despised and feared because it destroys experts."

However, epiphanies are essential for progress, and we're eager for lots of them to occur among accountants and others, including managers. So, let's make this student's situation applicable to more people.

First, notice that she is not a newcomer to accounting - she has been working at it for quite a while, and probably has accumulated expertise and confidence that what she is doing is worthwhile. Like all of us, she has grown comfortable with the world around her and the corner of it that occupies her time and attention during the week. We're guessing that she takes satisfaction from doing her job well - and rightfully so.

But it also sounds to us like she may not have paid enough attention to the purposes of the information that she has been accumulating and passing on. Although she is aware of her ethical obligation to do her best, she had slipped into the mode of thinking that GAAP is a suitable definition of what is best.

Having been introduced to accounting through a traditional education process, and then trained and supervised by others with similar backgrounds, she had no inclination to identify, much less analyze and resolve, the issue of whether complying with GAAP actually provides useful information.

If GAAP is considered to be carved in stone, it's beyond criticism and incapable of improvement. Furthermore, she embraced the simple and widespread concept that it is ethical to comply with GAAP and unethical not to.

The new light bulb in her head came from presentations showing that the Financial Accounting Standards Board and all its predecessors are political institutions created to provide answers to controversial questions. The controversies arose, are arising, and will arise from tension between management's desire to present a favorable image in its reports, the users' desire to glean the truth, and the auditor's desire to have shelter from recrimination for allowing false images to be published.

These different and conflicting interests struggle against one another in a setting in which society needs the system to produce useful information that promotes capital market efficiency, thereby lowering systematic risk and producing lower (but realistic) capital costs so that the economy creates more wealth and distributes it more equitably.

With all those expectations riding on GAAP's shoulders, it can only be true that political considerations have shaped and will shape the principles that are eventually voted into effect. Even though these ideas are very understandable, they are not part of the traditional accounting education, certainly not at the introductory level. They probably have been presented in just a few advanced classrooms only occasionally over the last couple of decades, and not at all before then.

Well, so what?

As we see it, this political perspective on standard-setting reveals that reporting in accordance with GAAP will never provide the capital markets with the information they need. One reason is that an elaborate due process has been put into place to "protect" the interests of the different parties.

Besides taking years, the process forces FASB to consider all possible solutions, however off-the-wall and biased they may be. Diplomacy is elevated above decisiveness, and the urge to balance opposing views compromises the integrity of the standards. After all, if a due process calls for soliciting comments, you cannot very well ignore them and press ahead to the solution that you decided made the most sense before you asked. The irony is that the process is supposed to add authoritativeness to the standards, but actually works to deprive FASB of its authority.

We shudder about the further reduction in the speed of the process and the integrity of its standards in an environment in which everyone is urging convergence of U.S. GAAP with international standards. If you think we get strange answers out of a process that builds a consensus among seven American accountants, just think what is involved in building a consensus among not only those seven, but also the 14 members of the International Accounting Standards Board.

The difficulty is immense once you realize that these people, in effect, represent different constituencies with different interests, different economic systems, and potentially quite different ethical environments. In some societies, for example, great value is placed on the ability to keep a straight face when speaking untruths. This ability to avoid embarrassing oneself and others is highly honored, even though neither the speaker nor the listeners would dare act on the information that has been released.

Another point in the note from the student is her deep concern that accounting principles actually change, a thought that has challenged her personal postulate that GAAP constitutes an anchored and immovable base for defining bedrock and inviolable ethical practices. We have to ask where she might have gotten this idea.

The answer is obvious - from our accounting profession, which has long advanced the dogma that compliance with GAAP is the only ethical action. Of course, when confronted with the political capriciousness of GAAP, she then had to face the fact that her ethical standard must then be unreliable too. Her confused reaction really is no surprise. It can be a profound shock to lose confidence in your ethical base. On the other hand, it can be liberating to discover that behaving ethically is not about following rules but telling the truth (because doing so is good for the economy and the society, not to mention the soul).

Within this paradigm, GAAP is transformed from a set of rigid, unbending rules to open-ended guidelines on how to construct stories that tell more of the truth, where truth-telling is the ultimate goal. Of course, the rub is that the political standard-setting process does not always move us in that direction.

Indeed, we are convinced that complying with GAAP may actually move us further from the truth, not closer. Thus, to a person who has had this epiphany, the changes in, and shortcomings of, GAAP inevitably lead to a serious ethical dilemma - "How can I possibly comply with these standards and tell the truth at the same time?"

Some wise people in the past acknowledged that possibility by creating the Rule 203 exception that demands departure from GAAP when compliance produces misleading information. Unfortunately, there are virtually no, if any, exceptions on public record. We take this fact as direct proof that it's time for more epiphanies.

For our part, we will do what we can to bring them on - one student and one reader at a time.

Paul B.W. Miller is a professor at the University of Colorado at Colorado Springs, and Paul R. Bahnson is a professor at Boise State University. The authors' views are not necessarily those of their institutions. Reach them at paulandpaul qfr.biz.

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