In early April, a former student sent us a quote from a senior official of what might be called a "constituent representative organization" by some folks, but a "Washington lobby" by others. This person claimed that the Financial Accounting Standards Board's use of values in expensing employee options had discouraged that form of compensation. This and other comments unveiled someone on the other end of the spectrum from us.To the entity's credit, we were able to get the official on the phone within two days, and a conversation took place as background, not for attribution. Our idea was to probe the official's mind to find out what makes such folks look at accounting so differently from us. It turns out that the rationale for criticizing value-based accounting was so weak that we couldn't resist responding in a letter. The recipient took it with aplomb, but had no solid rebuttal.

Because the public statements were so bold, we decided to present our follow-up letter in this column to encourage others to rethink their position. We also want to give ammunition to others who desire progress.

Dear [Anonymous]: Thank you for taking time to talk yesterday morning. It was helpful to hear you explain your aversion to reporting market values. We have to confess, though, that you didn't offer up anything that we haven't heard over the last 30 years.

When the Financial Accounting Standards Board was working on the Conceptual Framework back in the early 1980s, for example, countless letters and speeches made claims essentially identical to what you said yesterday.

Estimated values

Throughout our conversation, you used the phrase "estimated values" with the clear implication that these numbers are inferior simply because they are estimates. In response, we point out that real market values are not estimates at all, but actual amounts observed in transactions involving real companies.

When we step out of the traditional paradigm, we see a great deal of reliable information inherent in the economic activities of others that can be tapped into with little effort. Even the values of most physical assets can be observed in others' transactions. We're not talking about hypothetical amounts, but actual numbers, measured without subjectivity.

Costs are estimates, too

As a matter of fact, many, even most, costs are estimates; after all, land is the only tangible asset carried at original historical cost. Others are depreciated according to an assumed pattern over an unverifiable predicted life.

Further, original cost is often ambiguous and estimated. Consider that costs assigned to an acquired company's assets are their estimated market values. Perhaps the most bizarre and mind-twisting practice is impairment accounting, which writes assets down to values lower than cost, but not up. Certainly, if values are sufficiently reliable to be used below cost, they are equally reliable when they're higher.

Values and fraud

You also picked up on a recent fad that bashes value-based accounting by linking it to the crimes at Enron, as if the former enabled the latter. Instead, management's greed and lack of ethics led them to fabricate false numbers, and the auditors' greed and lack of ethics led them to say the numbers were good.

The obvious flaw in the Enron argument is that plenty of frauds have happened with fabricated costs. For example, the WorldCom scheme capitalized amounts that should have been expensed. Presumably those costs had the features of reliability that win praise, yet they were abused to produce the largest restatement in history. Those who steal will use whatever is handy, whether it's smooth words, a gun or phony numbers (cost or value).

Values and mergers

You stated that new accounting rules for combinations might require market values for both companies' statements, and suggested that that might chill M&A activity.

We're puzzled, because isn't it true that techniques for estimating values of acquired assets and debts can be applied just as reliably to the acquirer's assets and debts? What is chilling about that? If the goal is useful depictions that promote better decisions, then shouldn't best practices be applied to both sides? If they are, then reporting values for both parties will lead to more mergers, and better ones at that.

Truth in accounting

At one point, you questioned whether revealing truth is the goal of financial reporting by saying: "There is no truth in accounting." With the following modification, we can agree with you: "There is no truth in today's generally accepted accounting." That statement is accurate because of strong political resistance to replacing GAAP that no longer serves the capital markets, if it ever did.

But your statement begs the question of what quality of service financial reporting provides society if those who do it aren't searching for truth and better ways to communicate. If one presumes that truth can never be presented in financial statements, there is no reason to produce them. In contrast to your glib dismissal, the truth is revered by those serious about fulfilling accounting's social role. Your flippant attitude is regrettable, especially when expressed by an occupant of a responsible leadership position.

Theory and the real world

You also stated the cliché that value-based accounting is "good in theory, but not in the real world." This condescending statement is aimed at those of us who dare to imagine a system better than the present one. (We suspect owners of railroads and steamships in the 1920s said similar things about aviation.)

As we see it, that expression soundly condemns those who use it. What does it reveal about the ambitions of shareholders' stewards if they refuse to explore new practices with potential for better communication? It's even worse when they're proud of their disdain for improvement.

But let's pursue your thought a step further by looking at a few features of GAAP accounting and the gulf between its results and the real world. Consider inventory: Instead of observing actual flows, managers assume a flow according to what they want to report. In addition, the reality of manufacturing is that it must add value to the inventory, yet GAAP refuses to acknowledge that any has been added.

Consider depreciation: Instead of observing real values throughout assets' actual lives, managers assume that they lose predicted amounts over a predicted life in a predicted pattern. These practices are not even remotely connected to the real world. Rather, they substitute imaginary depictions of what managers wish would happen for factual descriptions of what actually occurs.

It is clear that generally accepted accounting principles accounting is neither good in theory nor remotely related to the real world. Without a doubt, there is a crying need for reform and there is no justification for satisfaction with the status quo.

In conclusion

We could go on, but we won't. You were gracious to give us your time and your thoughts. We appreciate it more than you realize, and perhaps more than our comments suggest. In any case, we hope these thoughts will challenge you and others in a positive way.

The future of financial reporting can be much brighter than its past, and everyone, even the managers you often speak for, will be better off when values are reported.

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

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