Every so often, people and organizations mistakenly become so self-satisfied that they stumble into assuming their own infallibility, often accompanied by smug statements. Inevitably, events turn these boasts to dust.
Here are a just few examples that should raise a chuckle or two. Charles Duell, then-head of the U.S. Patent Office, remarked in 1898 that, "Everything that can be invented has been invented." Harry Warner, a successful producer of silent movies, responded incredulously to a new idea in 1927 by saying, "Who the hell wants to hear actors talk?" Another case where satisfaction with the status quo turned out to be off base is Tris Speaker's 1921 wise judgment that, "Babe Ruth made a big mistake when he gave up pitching."
So what does this have to do with accounting? Quite a lot, actually, and we're shocked because the tragic heroes are our good friends at the Financial Accounting Standards Board. At the end of April, the board issued an exposure draft on the hierarchy of generally accepted accounting principles. As the only organization authorized to create U.S. GAAP, FASB is proposing to exercise that authority by determining the status of various documents and pronouncements that prescribe acceptable practices. This move is politically appropriate, because the hierarchy heretofore belonged to the American Institute of CPAs' Auditing Standards Board through SAS 69. Now that the Public Company Accounting Oversight Board has supplanted the ASB, FASB is taking charge.
Consistent with its perennial desire to diminish controversy, the board's draft does not propose many changes in the hierarchy's content, offering up small tweaks, such as clarifying that the highest category includes Statement 133 implementation issues, which obviously could not have been specifically addressed in the two-decades-old SAS 69. In justifying its light touch, FASB says that it postponed hopes for "reducing the complexity of the hierarchy and elevating the ranking of the FASB concepts statements" until completing its codification project.
We were nodding in agreement with these changes until we were startled out of lethargy by Paragraph A10 in the draft, where the board deals with so-called Rule 203 exceptions.
In doing so, our friends seem to have stepped over the edge by presuming that they have omniscience as to what constitutes quality information. While everyone is entitled to think highly of their own work, none can intelligently forget their fallibility. We're writing this column to call them back to reality.
As our readers probably know, Rule 203 of the AICPA Code of Professional Conduct first stipulates that a CPA cannot opine that financial statements present fairly in accordance with GAAP unless they comply with all pertinent GAAP. With great wisdom, those who created Rule 203 provided an exception that kicks in if the CPA "can demonstrate that due to unusual circumstances the financial statements would otherwise have been misleading."
Specifically, the rule permits the accountant to embrace another practice if the generally accepted solution will produce misleading statements.
As might be expected in a professional culture that values compliance with rules more than truth-telling, relatively few Rule 203 exceptions actually happen. (A former chief accountant has told us that he knows of four.) When they do occur in public statements, the Securities and Exchange Commission staff looks askance at them and demands solid justification. Perhaps surprisingly, they do not automatically reject the exceptions, but actually work with those involved to produce better information.
As we see it, the exception clause is highly important because it offers an escape route for anyone who has the courage to shake their fist in the face of a political system that consistently produces compromised standards that diminish quality.
So what does FASB propose? Nothing short of eliminating Rule 203 exceptions! Paragraph A10 boldly states, "The board believes that the selection of accounting principles in accordance with the GAAP hierarchy results in relevant and reliable financial information. Therefore, an enterprise cannot represent that its financial statements are presented in accordance with GAAP if its selection of accounting principles departs from the GAAP hierarchy set forth in this statement and that departure has a material impact on the financial statements."
In many fewer words, we summarize that the members have essentially proclaimed their infallibility in producing the best possible solutions to all accounting issues forever and ever. Such pride is inconsistent with having a Conceptual Framework that provides a vision for building a better accounting world.
Furthermore, this kind of pride always leads to a fall.
Their claim would be reprehensible even if GAAP were any good. In light of the many obvious shortcomings in financial reporting, this assertion is unjustified. As our regular readers know, we find fault with virtually all acceptable practices, and see plenty of room for improvement. (We have coined these alternative and more accurate acronyms to replace GAAP: PEAP, WYWAP and POOP, which we will explain in upcoming columns.)
For example, our column in the previous issue showed how pension accounting is so bad that it is nothing short of sanctioned fraud, because it leads to financial statements that are completely out of touch with reality. Alas, pension accounting is not the only case in point. We can also cite bad practices for receivables, inventory, tangible assets, intangibles, leases, investments, business combinations, current liabilities, long-term debt, contingencies, convertible securities, stock options and cash flows. Virtually everything in GAAP can be improved, and most of it can be improved immensely.
Yet FASB is essentially claiming that there are no shortcomings, in effect proclaiming that, "If it's GAAP, it's got to be good!" The overreach is magnified by the presumption that only the board is capable of identifying and fixing any future problems. We cannot imagine how the members could be any further from the truth, and we are somewhat troubled by their apparent hubris.
As life makes abundantly clear, great risk lurks in presuming the present situation is as good as it gets. It just isn't so. Indeed, we consider it undeniable that a great many reforms are and will be needed. Inherent in rescinding 203 exceptions is FASB's erroneous assumption that it is the only institution or actor that can anticipate the circumstances that trigger the need for new GAAP and then act quickly to implement new rules. A review of FASB's history shows that such pro-active leadership, speed, creativity and decisiveness have never existed. Instead, it has been reactive, slow, pedestrian and indecisive. It seems to us that the institution will have to experience some sort of makeover to live up to this responsibility.
But there's more that makes this move troubling. There simply has to be an avenue open for future managers who will choose to innovate by publishing truly useful information. While this species is admittedly rare today, we know that individual initiative in search of lower capital costs through greater quality will be an important avenue for progress in financial reporting. We're bothered that FASB's presumptive act will cut it off entirely.
We are certainly content to give the board political control over what's generally acceptable, but we are absolutely against granting it the ability to preemptively label all other information as automatically non-useful merely because it hasn't gone through a convoluted political process that virtually always sacrifices usefulness to gain acceptability.
Our solution is straightforward. The board must rewrite Paragraph A10 to state that departures from GAAP are expected to be rare and that, when they occur, they must be clearly justifiable on the basis that generally accepted practices produce misleading information, and the nonstandard practices produce useful information. Of course, we're content to subject any departure to review by auditors and regulators. Arming them with this two-pronged test should clamp down on bad accounting while guaranteeing that a way is open for innovation.
Over the years, we have found ourselves playing a strange role, in that we have often been both the board's staunchest defenders and its strongest critics. Such is the dual role that we are now filling, and we call on our friends to avoid the mistake of deciding that they alone know the best way to describe reality. They're not close enough to that level of omniscience to make a credible claim. And even if they were, they would also be wise enough to know that they can't anticipate the future any better than the rest of us.
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