We have both recently experienced sobering thoughts with the untimely passing of a friend and colleague. The event made us mindful of the frailty of life and our interconnectedness.
This introspection brought to mind the timeless John Donne meditation that says: "No man is an island, entire of itself ... any man's death diminishes me, because I am involved in mankind; and therefore never send to know for whom the bell tolls; it tolls for thee."
With less sobriety, we also reconsidered the words of Bob Dylan in "Moonlight," who, despite tortured syntax, asks the same question but provides a more inclusive answer: "For whom does the bell toll for, love? It tolls for you and me."
As we were sorting through our feelings, news of the Bernie Ebbers trial also reached us. The gavel had fallen - guilty on all counts. We're confident that there have been more than a few smug smiles and self-righteous back slaps as accountants and others gloat that one of the high and mighty has fallen. But the words of Donne and Dylan remind us that none of us should consider ourselves to be an island, separate and apart, and unaffected by the events around us.
In the Ebbers case, it would be a mistake for accountants, auditors and others involved in financial reporting to assume they are in a safe harbor unaffected by his fraud and his fall. Why? Simply because much of what passes as generally accepted accounting principles is also fraud. That's a bold statement, but we can back it up.
Consider this definition, which we found at www.lectlaw.com/def/f079.htm: "The term 'fraud' is generally defined in the law as an intentional misrepresentation of material existing fact made by one person to another with knowledge of its falsity and for the purpose of inducing the other person to act, and upon which the other person relies with resulting injury or damage. [Fraud may also include an omission or intentional failure to state material facts, knowledge of which would be necessary to make other statements not misleading.] To make a 'misrepresentation' simply means to state as a fact something which is false or untrue. [To make a material 'omission' is to omit or withhold the statement of a fact, knowledge of which is necessary to make other statements not misleading.]"
When, like an egg to a candle, we hold GAAP reporting up to the bright light of truth, we shudder because so much of it constitutes fraud.
An easy one is stock options: Surely everyone with a shred of intellectual honesty knew that options have value, that they were presented to employees for work done, and that income statements were incomplete without compensation expense. So, knowing those facts but presenting earnings without the expense meets the definition of fraud, especially if the reporting management's intent was to use higher numbers to induce the markets to pay too much for the company's shares.
As we see it, this option bell also tolls for auditors. How can they say that the statements fairly presented the financial position and results of operations if the options expense and the options liability were not (and still aren't) usefully reported?
And how can the Financial Accounting Standards Board escape the gavel by having made expensing optional, simply to bring an end to the "divisive debate" and keep standard-setting in the private sector? And doesn't responsibility extend to the Securities and Exchange Commission for not having the backbone to say that statements without reported options expense were fraudulent?
What about inventory? Can anyone claim that the acceptability of LIFO, FIFO, average and combinations constitutes reporting the truth? Isn't it possible that they all misrepresent "material existing facts" by not revealing both the fair value of the inventory and the fair value of the sold goods?
Depreciation is a fraud that dates back at least to ARB 27 (December 1946). Why? Because the persistent reporting of assets at book value instead of what they are really worth constitutes "intentional misrepresentation of material existing fact." The resolute policy of not reporting value is also "an omission or intentional failure to state material facts, knowledge of which would be necessary to make other statements not misleading." We can only conclude that reporting book values is a fraud, because it is stating "as a fact something which is false or untrue."
What about the never-ending application of lower-of-cost-or-market and impairment accounting? Surely, this practice intentionally fails to state material facts "for the purpose of inducing the other person to act." If market value is more useful than book value when it's lower, then it's more useful when it's greater.
And, then there's pension accounting, which we happen to think amounts to racketeering because those who use it are repetitively committing fraudulent financial reporting. How can anyone justify recognizing an expense that reflects the market return that was expected by the actuary instead of the return that was actually experienced?
The FASB of the mid-1980s knew what it had done with SFAS 87, and admitted in the standard that its requirements caused the most useful information to be omitted from the financial statements, a fact that can only mean that reporting the useless information in those statements is nothing short of fraud.
The list could go on and on and on. Virtually every generally accepted practice gained that status through a political process conducted by accountants to satisfy the needs of accountants and managers. The general retreat to historical cost, for example, is still justified by an abhorrent fear of opening the door to fraudulent appraisals.
The rational (and honorable) reaction to that risk is to develop stronger auditing standards and ethics rules that force auditors to actually judge information's reliability, instead of management's compliance with an arcane set of rules. There is no valid reason to retreat to the fraud of reporting cost-based numbers that are known to be misleading, instead of reporting value-based numbers that can be made very useful.
Of course, the blame doesn't stop at the edge of the profession. Besides standard-setters and regulators and educators, we point a bony finger of condemnation at the press and the media, because they so willingly, even blithely, receive and pass on financial statement numbers as if they are gospel truths. If it were up to us, we would defrock anyone who writes or talks approvingly about earnings per share and a company's failure to meet "expectations."
Simply put, they have no clue! There is no precision in EPS, first because the numerator is too nebulous, arbitrary, compromised and imprecise, and second because the denominator is too fictional to be any good. Further, it's nothing short of fraud to promote the idea that a complex firm's activities could be boiled down to a single metric.
So, what did Ebbers get?
We think he got what all of us deserve. Of course, there are degrees of fraud, and what he did, at least in the jury's eyes, is about as bad as it gets. However, this same gavel should easily drop for the rest of us with a resounding crack after the jury foreman utters, "We find the defendants guilty of fraud in the first degree."
It's well past time to come to grips with the fact that it's well past time for massive reformation. And it's way past time to stop waiting passively for FASB, the International Accounting Standards Board or the SEC to force it on us. True reform will come only when accountants and managers abandon their fraudulent habits and commit to telling the truth.
In the meantime, all who implement, create and audit GAAP should be looking over their shoulders. The same gavel that fell for Bernie Ebbers can, and should, fall just as easily for the rest of us.
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.
