We're sneaking up on the 300th installment of "The Spirit of Accounting," an occasion that has prompted us to look back over not just the years since it first appeared in 1996, but even further back to when we were accounting students.
In planning this column, we laughed over some Jeff Foxworthy humor, specifically questions he labels, "Things I Thought I Would Have Understood by Now." One asks, "Why does lint collect in my belly button?" Another is just as mystifying: "Who closes the door on the bus after the driver gets off?"
We also noted the recently announced goal of the Obama administration of moving toward "a single set of global accounting standards." (Accounting Today, July 20-Aug. 16, 2009, page 1). We've previously expressed skepticism over convergence because of two factors. One is the inappropriate influence of statement preparers and politicians over the International Accounting Standards Board's affairs. The second is that not much good will come from converging U.S. GAAP and International Financial Reporting Standards on each other; rather, the aim should be convergence on high-quality new standards that reveal the truth, the whole truth, and nothing but the truth to the capital markets.
Those standards do not yet exist, so the present approach to convergence will be like watching dud fireworks - lots of anticipated excitement followed by a cloud of smoke and great disappointment.
We also recently stumbled across this wisdom attributed most often to Einstein: "Insanity is doing the same thing over and over again and expecting different results."
To combine these three disparate thoughts, we believe that no effort should be made to converge until the IASB becomes truly independent, and accountants stop doing what they've always done after finding suitable answers to the following 30 questions. (We reserve the right to ask others later.) 1. Why does anyone consider historical cost-based numbers to be useful for financial decisions? (It's like trying to drive a car without any idea of where you're going while looking only in the rearview mirror.)
2. Why does anyone deny that more value-based numbers in financial statements would be useful for financial decisions?
3. Why do accountants think and act as if realization of gains and losses is an important income-producing event, and why does anyone tolerate (and standard-setters indulge) auditors' penchant for recognizing unrealized impairments but not unrealized gains?
4. Why do accountants blithely combine financial measures from different points in time, such as subtracting depreciation expense in 1980 dollars from revenues expressed in 2009 dollars?
5. Why do accountants think systematic depreciation based on past (even long-past) predictions and assumptions provides useful information for any financial decisions?
6. Why do accountants ignore changes in liability values (up or down) and continue to apply a debt's original discount rate until it's paid off? (We recently read that many accountants are aghast at the idea that a borrower could actually have a gain when its liabilities decline in value.)
7. Why don't accountants apply significant digits when every high school science student knows that imprecise data cannot be used to produce precise calculations? For example, accountants would depreciate an asset's cost of $4,569,244.73 over a predicted life of five years at $913,848.95 per year, even though the result can have only one significant digit of mathematical accuracy. (Of course, there's not even one relevant digit in that result.)
8. Why do accountants and managers use indirect operating cash-flow presentations when the Financial Accounting Standards Board and users have clearly proclaimed their preference for the direct method?
9. Why should management's alleged intent trump economic reality when it comes to accounting for investments, especially whether unrealized gains or losses are included in reported earnings?
10. Why do U.S. accountants unthinkingly accept both LIFO and FIFO as perfectly acceptable assumptions and even combinable in the same income statement? (Incidentally, 2009 is the 70th anniversary of LIFO's acceptability. How's that for an up-to-date standard?)
11. Why do accountants think they're providing useful information about a manufactured inventory by not reporting value added to the inputs, presumably the sole purpose for production activity? (Instead of describing the output's value, they report inventory at the sum of allocated input costs, including systematic depreciation in historical dollars.)
12. Why do otherwise financially astute individuals fall for deferred tax liabilities and tax expense reported at dollar amounts expected to appear on future tax returns, thereby failing to recognize the economic advantage of postponing cash payments? (Even fifth graders now learn about present value.) 13. Why does anyone think the equity method provides useful information about an investment?
14. Why would anyone think new basis accounting for combinations would not provide useful information? For that matter, why do users still tolerate today's statements with purchases and poolings based on old, even very old, numbers?
15. Why is stock option compensation treated like deferred cash compensation? (The stock options' original value is allocated over the vesting period, while completely disregarding all subsequent changes in their value.)
16. For that matter, why would anyone honestly think option compensation produces no cost?
17. Why do managers and auditors passively rely on the tortuous political standard-setting process to tell them what information to provide to the capital markets, instead of performing their own research to discover what those markets actually want but aren't getting?
18. Why do managers think it's suitable to do the very least required by the law and GAAP, instead of trying to surpass each other by providing more frequent reports containing more useful information? (As we see it, accounting standards are like a high-jump bar that winners should want to sail over. In contrast, most seem to think the game is limbo, where they win by just barely scraping under the bar. We also note that high-jump bars are raised, while limbo bars are lowered as the game progresses.)
19. Why do managers believe that capital markets are fooled by GAAP reporting that conceals real economic volatility, instead of revealing it?
20. Why do managers think obfuscation in financial statements leads to higher stock prices? (In fact, reducing information's accessibility increases uncertainty and raises risk, thus pushing stock prices lower, not higher.)
21. Why do managers, accountants, auditors and Congress act as if market efficiency will be promoted by incomplete and otherwise deceptive reporting policies that purposefully cause financial statements to omit important but inconvenient facts, namely changes in fair values?
22. Why do managers think that no one realizes or cares that their financial reports are useless for any real purpose except legal compliance? (Just because people read 10-Ks and annual reports doesn't mean that they either believe or act on their contents, which often don't describe the truth. In any other setting, we think institutionalized prevarication on the scale of GAAP reporting would be prosecuted, not treated as responsible professional behavior.)
23. At the end of an audit, why do auditors ask only whether the financial statements comply with GAAP, instead of whether they contain useful information?
24. Why do the business media think GAAP earnings are newsworthy and highly precise measures of some sort of truth, instead of woefully incomplete, arbitrary and often manipulated misrepresentations?
25. For that matter, how could anyone possibly attribute significance to earnings per share when the numerator and denominator are both rubbish? (Rubbish divided by rubbish is still rubbish, no matter how precise the quotient looks.)
26. How could anyone believe any GAAP measures related to defined-benefit pension plans? (Everything about them is distorted to create false appearances, yet no one is complaining.) 27. How can managers who use operating leases to create off-balance-sheet financing believe they're fooling anyone but themselves?
28. Why have standard-setters and regulators allowed managers to leave so many leases off their balance sheets for at least 35 years?
29. Why do accountants continue to partition assets and liabilities into current and non-current categories according to a compromised rule created in the 1930s based on observations of what accountants were doing then, instead of what users need to know now?
30. In a time that makes financial information from virtually any market in the world instantly available, why are regulators, managers and accountants still satisfied with issuing unaudited GAAP financial statements only once every three months?
We contend that absolutely no one in the financial community should have even the least bit of honest satisfaction that the status quo in financial reporting provides useful information. If the administration really wants a single set of useful global accounting standards, they need to start by liberating the economic world from the tyranny of inferior standards that date back to the 1930s and even earlier, and then go to work on creating new attitudes that respect complete and true reporting.
We don't know whether anyone can stop the present convergence juggernaut, but we want to at least slow it down so it has a chance to be done right, even if that means raising challenging questions. Maybe answering them will put an end to the insane repetition of the same incomplete accounting practices.
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
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