by Paul B.W. Miller and Paul R. Bahnson
By now, millions of words have been written about the fall of the accounting profession to its lowest levels of prestige and respect in its 100-plus years of life.
Ominous swells on the financial reporting ocean appeared with frauds at Waste Management, Cendant and Sunbeam. They foreshadowed a tidal wave that rose with Global Crossing and then crested and crashed with a deafening roar with revelations about Enron, Andersen, Tyco, Adelphia, WorldCom, Qwest and now HealthSouth.
An echoing wave has ravaged the investment banking/financial analyst side. Still another has hammered the New York Stock Exchange over the actions of its market makers.
And no one should forget how the scandal spread to the Securities and Exchange Commission itself, culminating in Harvey Pitt’s resignation after his clumsy efforts to sculpt the Public Company Accounting Oversight Board to meet the needs of those who put him in office, namely the big firms and the American Institute of CPAs.
We cannot fathom how any among us can deny that the accounting world has changed irrevocably. So much has been lost through the combined efforts of so many.
When it comes to identifying the causes for this collapse, it is easy to point fingers at others. For example, the AICPA is to blame for letting our ethics code erode, both in content and in enforcement, to the point that it has become meaningless. This decline surely weakened the power of auditors to resist their clients’ attempts to manage their statements.
Auditors are to blame for selling out their integrity by going to fixed-fee audits and by acquiring clients by first blessing their strange accounting practices and then inventing more deviant methods. The pursuit of consulting and tax fees also added to the fall.
Corporate managers are to blame for trying to deceive investors through deficient reporting. Still more blame goes to regulators and Congress for failing to stand for integrity with any real backbone.
All this finger-pointing has already been done. What we want to add is a reproach directed at our own branch of the profession. Why blame academic accountants? Although no one will ever know for sure, we believe that most of, even all, the miscreants were either accounting majors or students with at least one accounting course on their transcripts. If we’re right, those who taught them failed to provide the needed foundation.
As former Financial Accounting Standards Board member and former SEC chief accountant Walter Schuetze explained one time, the capital markets are a figurative crystal vase, highly valuable but dangerously fragile. This vase has been entrusted to the accounting profession for safekeeping, and all that we do must be aimed at protecting it.
For accounting students, the academic accountants in their lives failed in three ways. First, they did not provide their pupils with a solid appreciation for the capital markets. In particular, there is good reason to consider the markets to be highly efficient in terms of their ability to understand business and to penetrate smokescreens enabled by generally accepted accounting principles.
Clearly, the markets are not omniscient because they do get fooled from time to time, but not for long. Another point about the markets that the students were not taught is the clear relationships between the quality of the information in the financial statements, the risk faced by investors, and stock prices. When quality goes down, risk goes up and stock prices go down. Because accounting faculty didn’t fully instill these ideas in their students, they conspired (wittingly or unwittingly) in the fraud that has damaged the credibility of all managers and auditors.
Second, we think academic accountants have failed to point out GAAP’s shortcomings in both public forums and in classrooms. Students need to be taught to evaluate GAAP instead of just committing it to memory without questioning whether those principles can produce useful information.
We’re afraid that too many of us adopted the attitude that students need to learn GAAP and then get out there and implement it, all without asking whether the output makes any sense (which it often doesn’t).
Professors who teach GAAP without assessing usefulness surely contributed to the pervasive attitude that GAAP is good enough. Undoubtedly this omission fostered the attitude that financial reporting is a compliance exercise and not a critical information delivery system that anchors our capital markets. The failure to speak out about GAAP shortcomings may have kept auditors from seeing the harm in putting unqualified opinions on totally misleading GAAP financial statements.
Third, it seems to us that our colleagues who instructed these accountants also failed to establish any commitment to our profession’s longstanding duty to do what is right for the capital markets and the greater economy. Instead, we fear that educators have somehow glossed over the value that it’s suitable, even smart, to elevate individual and firm interests above those of the markets and society as a whole.
By this omission, the academics contributed to many poor choices, including the documented decision by Andersen officials to retain Enron as a client despite its aggressive accounting and dubious ethics simply because of the potential to milk the company for $100 million a year.
Putting these three failings together (inadequate teaching about capital markets, GAAP and ethics), we see that some accounting students were turned into weapons of mass destruction. Their pursuit of exaggerated wealth through deception (whether in violation of GAAP or in compliance) destroyed vast quantities of wealth and public confidence in the markets and the reporting system that sustains them.
The same shortcomings are apparent in the inadequate education that is delivered to non-accountants, primarily higher level managers. It appears that they have committed two accounting-related sins.
First, many attributed too much power to accounting, to the point of thinking that the reported numbers are all that matters, not what is behind them. Their reporting goal came to be publishing favorable numbers, not numbers that reflect what is going on. As Warren Buffett has explained, CEOs who manipulate financial statements run the risk of actually believing those false numbers.
Second, other managers did not attribute enough power to the numbers. Reports just became jokes to be thrown together and sent to the public without regard to the messages that they contained. Most often, those messages were subliminal signals that managers had no respect for the markets’ ability to penetrate accounting ploys. Exhibit A for our case is the virtually unanimous decision to put options expense in the footnotes instead of the income statement. We blame these managers’ instructors for not revealing the dangers in these attitudes while they were in their accounting classes.
Thus, we’re convinced that our branch of the profession helped knock the huge hole in the bottom of the accounting ship. In all likelihood, we have committed our own sins in this area. But, to our knowledge, neither of us has produced students who have committed fraud to this scale, if at all. We cannot imagine the grief and embarrassment that must be felt by our colleagues who had these people in their classes.
Here’s the bottom line: The accounting academy is in need of its own reforms. We hope that we’re collectively up to the task, and not just hiding our heads in the sand. There is much work to be done to prepare the next generation of managers and accountants so that they don’t repeat the transgressions of their predecessors.
