For the last two months, we've been describing the Financial Accounting Standards Board's recent exposure draft on the hierarchy of principles, specifically its assertion that compliance with published generally accepted accounting principles always leads to relevant and reliable information. Our previous four columns describe the intolerable flaws in this premise.
The first two focused on FASB's proposal to eliminate Rule 203 exceptions that permit, and even encourage, departures from GAAP, when compliance would produce misleading financial statements. This clause is essential for innovation when the old way can no longer be considered adequate.
The next two explained why published GAAP cannot fulfill the role that the board members now ascribe to it. In particular, much of GAAP is really PEAP (Politically Expedient Accounting Principles), because it is shaped by pressures and compromises. We also described how much of GAAP is WYWAP (Whatever You Want Accounting Principles), because it embraces divergent alternatives, such as FIFO and LIFO. Comparability cannot be achieved with this much diversity, and, without comparability, the information cannot be useful.
This column describes yet another reason to doubt FASB's premise.
Consider what it would be like if the computer industry had been content with technology as it existed in the 1970s: We would be using punch cards and reading printouts on green-striped pages with little holes along the sides. No computers on every desk, no e-mail, no Internet, no gigabytes of storage, no digital cameras, no iPods, no cell phones - none of that.
What if your doctor recommended a mustard plaster for your respiratory infection? What if cars still had to be crank-started, and had no air conditioning, cruise control or remote-control key fobs? What if the only way to travel cross-country was by train?
Perhaps our point is made - change is the only constant, and woe unto those who deny its existence! Commerce is always moving ahead to provide more and better services and serviceability, generally at lower prices. Everything, that is, except GAAP. In fact, many principles are so ancient that we call them POOP, for "Pitifully Old and Obsolete Principles."
The origins of cost-based depreciation are virtually lost to everyone's memory. The older one of us recalls learning accounting from a gentleman who had been teaching since the 1920s, and his explanation that depreciation became common in the 1930s as a rough-but-ready improvised substitute for discretionary charges against income.
The original authoritative reference to depreciation appears in ARB 43 that codified previous rules, specifically ARB 27, which was issued in 1946 and described depreciation in the context of emergency facilities constructed during World War II. That's 59 years ago.
How absurd that there has never been any official modification of this makeshift practice of predicting future events and then reporting years later as if those predictions are valid. To tell the whole truth, the APB did reconsider depreciation back in 1965 in Opinion 6, but only endorsed it as it was practiced.
However, consider the irony of this 40-year-old dissent from board member Sid Davidson: "Mr. Davidson agrees with the statement that at the present time 'property, plant and equipment should not be written up' to reflect current costs, but only because he feels that current measurement techniques are inadequate for such restatement. When adequate measurement methods are developed, he believes that both the reporting of operations in the income statement and the valuation of plant in the balance sheet would improve through the use of current rather than acquisition costs. In the meanwhile, strong efforts should be made to develop techniques for measuring current costs."
In fact, there hasn't been even a weak effort, except perhaps for SFAS 33 in 1979, a quarter-century ago. Even then, depreciation was calculated (not observed) by dividing an asset's estimated market value by its predicted service life.
Thus, GAAP depreciation is pure POOP that robs financial statements of their usefulness. Nonetheless, FASB claims that it's as good as gold.
There can be no doubt that business combinations are frequent and significant. Yet what is the state of accounting practice? Until a few years ago, when FASB disallowed pooling, it had been virtually unchanged for decades, dating back to ARB 51, which came out in 1959. When FASB acted (over huge protests), all it did was cast in concrete the purchase method, another pitifully obsolete practice.
Although the board is now tweaking the purchase method, this will not begin to wipe away the accumulated dust and grime of the ages. Specifically, even an improved purchase method will continue adding current and relevant measures of the acquired assets and liabilities to the old and irrelevant balances on the acquirer's books. Good information plus garbage still equals garbage.
The obvious improvement would combine market value measures of both parties' assets and liabilities. It isn't a matter of reliability: If today's technology produces reliable market values for the acquired company's assets and liabilities, it can also be applied to the acquirer's balances. Clinging to purchase accounting creates nothing but POOP.
Few people know of the struggle that happened in the 1960s as the APB tangled with convertible debt. Opinion 10 (issued in 1966) called for dividing the proceeds of issuing convertibles into a liability and equity, with the latter equal to the value of the conversion feature. Twelve months later, Opinion 12 put that change in abeyance until it could do more research and respond to the "views of interested parties" that opposed it. Fifteen months later, Opinion 14 slammed the door, and convertible bonds are reported as if not convertible at all. The justification is based in large part on the impracticality of measuring the value of convertibility, at least with 1960s financial technology. This reason is, of course, completely obsolete.
What is the consequence of ducking this issue? You'll find it expressed in contingently convertible zero-coupon bonds. The rocket scientists who create them craft the conversion feature to have sufficient value to offset the time-value discount, thus causing the zeroes to be issued at their nominal face value. Because the conversion feature is not segregated, the issuer reports no interest expense, even though it has obviously gone into debt.
Although the Emerging Issues Task Force cleaned up an earnings-per-share reporting issue in 2004, the POOPy accounting remains intact 36 years later.
Space unfortunately keeps us from going into detail on other examples, but consider these essentially unchanged POOP:
* Treasury stock - ARB 1, 1939, actually dating back to 1933 (72 years);
* Stock splits and dividends - ARB 11, 1941 (64 years);
* Inventory and cost of goods sold - ARB 29, 1947 (58 years);
* Current and noncurrent classifications of assets and liabilities - ARB 30, 1947 (58 years);
* Long-term contracts - ARB 45, 1955 (50 years);
* Equity method - APB 18, 1971 (34 years);
* Receivables and payables - APB 21, 1971 (34 years);
* Stock options - APB 25, 1972 (34 years) (still de facto GAAP with the deferred implementation of SFAS 123R);
* Interim reporting - APB 28, 1973 (32 years);
* Income statement structure - APB 9, 1966 (39 years) and APB 30, 1973 (32 years); and,
* Research and development - SFAS 2, 1974 (31 years).
In addition, quarterly reporting for Securities and Exchange Commission registrants has been mandatory since 1970, more than 35 years ago. Have there been no advances in reporting technology since then? Sure, it costs something to report more often, but it costs even more to leave the markets in the dark for 90 days at a time.
Framing the issue
Here then is the issue facing our profession's leadership and membership: Are we going to seize the benefits created by the explosive rate of change, or are we going to keep pretending that nothing is changing? We fear that FASB's claim of infallibility for GAAP is a denial of the truth, when just the opposite is needed. Aggressive action is needed to purge GAAP of its political compromises, unjustified flexibility and grossly outdated standards.
So, we have defined the problem. Who agrees with us? And who will join in calling on FASB to stop producing and tolerating PEAP, WYWAP and POOP? In an era when society sees progress everywhere, why do accountants think the only good ways are the old ways? There is no rational explanation, and we're tired of this obstinance. Guess you could say we're POOPed out.
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 firstname.lastname@example.org.
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