This summer, Paul Miller and his family rented a cabin at the YMCA of the Rockies in Estes Park, Colo. On the wall was a copy of “The Four-Way Test of the things we think, say or do,” a well-known 80-year-old credo created by Herbert J. Taylor to guide himself and his employees through the Depression.

After his company survived with no layoffs and all creditors paid in full, he made it available to Rotary International to challenge its clubs and members to a higher standard.

Taylor’s test poses these questions (capital letters are in the original):

1. Is it the TRUTH?

2. Is it FAIR to all concerned?

3. Will it build GOOD WILL and better friendships?

4. Will it be BENEFICIAL to all concerned?

An activity is deemed ethical only if all four answers are affirmative.


We’re citing this test to explicitly confront our readers with the crucial question of whether preparing, auditing and distributing GAAP financial statements are suitable activities.

Over the last 20 years, we’ve used case studies, theoretical analyses, economics and common sense to plead with managers, accountants and everyone else to confront the reality that GAAP-based reports don’t fully serve anyone’s needs. We think it’s time to bring ethics into the discussion.

To be blunt, we’re asking whether it’s ethical to comply with GAAP.

Why are we using Taylor’s questions? Simply because they define time-tested impartial and independent assessment criteria. Their proven objectivity and rigor are essential for escaping the conventional self-serving insider’s conclusion expressed in the American Institute of CPAs’ Code of Professional Conduct that unsurprisingly deems issuing GAAP-compliant statements to be totally ethical.

Let’s see how this test turns out.


Even though the question, “What is truth?” has stumped philosophers for millennia, truthfulness is always among the essential qualities displayed in rational and successful societies. To understand why, imagine what would happen if no one could count on anyone to be truthful!

The U.S. legal system requires witnesses to swear to not just “tell the truth” but to tell “the whole truth” and “nothing but the truth.” Three parts are necessary because someone could tell a truth while omitting other pertinent facts and adding false statements. This oath allows the legal process to begin discovering relevant truths to help ensure justice is done.

We assert it’s equally essential that financial statements be completely truthful in order to accomplish the social goal of achieving significant macroeconomic advantages by ensuring that investment and credit decision-makers have useful information to support their judgments. Just as juries need the complete, unvarnished truth to render fair verdicts, capital markets can function efficiently only if they have relevant, true and complete information and don’t have to filter out falsehoods.

We present the following evidence as material to answering Taylor’s first question.

Exhibit A: As our October column explains, depreciation costs have been expediently fabricated since the 1830s by relying on a dubious premise that all assets lose value, a questionable initial valuation based on capitalized costs instead of fair value, and three unverifiable predictions of future events. Therefore, those calculated numbers cannot provide relevant and reliable information about assets’ values on balance sheets or the actual income results of using them.

These nine additional exhibits (among others) consist of totally false messages propagated under GAAP:

  • Exhibit B: Research and development expenditures are fruitless because they never produce assets.
  • Exhibit C: Operating leases don’t create assets or liabilities.
  • Exhibit D: Annual defined pension costs aren’t volatile.
  • Exhibit E: Income tax expense equals the undiscounted sum of taxes that have been paid, must be paid soon, and might be paid in the future.
  • Exhibit F: The taxes that might be paid are a real liability.
  • Exhibit G: Stock option-based compensation never exceeds the options’ grant date market value.
  • Exhibit H: Treasury stock purchases have no economic consequences.
  • Exhibit I: Interest rates never change.
  • Exhibit J: Unrealized asset impairments frequently occur but unrealized enhancements never do.

This evidence proves that Taylor’s first test is not passed. Therefore, those who present GAAP-based financial statements are acting unethically.
The other parts of the Four-Way Test also drive that point home.



Answering this question requires identifying who is “concerned” with GAAP financial statements’ contents. Our list includes existing and potential shareholders, creditors, employees and customers, as well as financial analysts, supply chain members, auditors, the general public, regulators, managers, CFOs and other financial executives, accounting professors and students, and possibly others.

We note the question doesn’t ask whether the activity’s outcome is fair to those who are the most concerned, have the most power, or make the rules. Instead, it asks whether the outcome is fair to all.

Without exception, every standard included in GAAP emerged from political processes that enabled those with power to gain results that are unfair to others and even, unwittingly, to themselves.

For example, consider the unfairness wreaked by the controversial standards for pensions, cash flows and stock compensation, where the Financial Accounting Standards Board admittedly compromised away the best solutions in response to threats to its continuing existence.

Alas, history shows that the interests of statement users and the general public in useful financial statements have consistently had less influence on standard-setters than preparers’ unfounded worries about compliance costs, volatile reported earnings, and strategic secrets, with equal or greater weight placed on auditors’ exaggerated fears of recrimination and regulators’ self-serving desires for enforceable bright-line standards. The evidence is too voluminous to detail, but our prime exhibits consist of all cost-based measures because they don’t serve the capital markets’ needs.

Therefore, we conclude that GAAP statements are not “fair to all concerned” and that those who present them are, in fact, acting unethically.



Applying ordinary language, this question essentially asks whether GAAP financial reports cause their users to have a high regard for accountants’ ethics and trustworthiness. If, as we’ve shown, those statements don’t present the truth, the whole truth, and nothing but the truth, are users pleased to do business with and otherwise rely on accountants, managers and auditors?

The question also asks whether the examined activity encourages the involved parties to be better friends. That is, do they enjoy mutual trust, eagerly seek out the other’s companionship, share respect, remain loyal, and come to one another’s aid?

To the contrary, our experience with financial analysts shows that they trust virtually no one who publishes GAAP reports because our consulting clients always pose this unfriendly question: “What are the managers and auditors trying to hide?” It also appears to us that auditors and their clients don’t trust each other very much. Further, we observe that hardly anyone trusts FASB, and that the Securities and Exchange Commission trusts nobody!

Because good will and friendships cannot exist between people who neither respect nor trust each other, our answer to this question is “No,” which means that presenting GAAP-compliant financial statements fails the ethics test yet again.



We find this fourth test to be the most rigorous because it asks whether the actions under consideration cause harm.

As an example of how they might cause harm, we observe that no one benefits from recognizing asset impairments but not enhancements. Specifically, managers are disadvantaged because they cannot report their successes unless they sell their appreciated assets. In addition, users suffer because they don’t get the whole truth about assets’ market values apart from impairments.

As a result, they can’t determine the combined market value of all assets because they only get an indecipherable aggregate of some assets’ market values and other assets’ depreciated book values.

We’re confident this undeniable bias is rooted in auditors’ misguided self-interest in minimizing the risk of recrimination for attesting to unrealized gains. In contrast, they’re perfectly willing to face that risk for unrealized losses because they can claim their “conservative” policy protects users.

However, this so-called protection presents statement users with a truth but not the whole truth.

As we see it, this time-worn conservatism excuse is a cop-out that transparently rationalizes a practice that doesn’t benefit anyone, much less everyone. Even auditors
aren’t helped because attaching their opinion to incomplete, conservative GAAP financial statements simply cannot add much value to them.

We confront the entire financial reporting community with the following negative economic consequences that inevitably result from not providing relevant information: Even after incurring information-gathering costs that greatly exceed corporate managers’ avoided compliance costs, users are forced to unreliably speculate about the real truth, thereby leaving them with residual uncertainty and risk.

Here’s the clincher that shows no one benefits from incomplete statements: Competition in the capital markets enables these under-informed users to discipline management by demanding higher return rates to compensate for their additional research costs and risk.

Thus, it’s clear that managers are penny-wise but pound-foolish because their higher capital costs exceed their avoided compliance costs.

Further, risk drives their share prices lower than they would be if the statements actually reported the truth, the whole truth and nothing but the truth.

Because GAAP reporting is not beneficial for managers, users or any other parties, it also fails this fourth test.



As irritatingly radical as our past pleadings may have been to some practitioners, they don’t compare to this column’s powerful message that Taylor’s independent test proves that all those involved in producing GAAP-compliant financial statements are acting unethically.

In light of the personal pride that most accountants feel about being more ethical than others, we hope this serious message will get through to them this time.

Thank you, Mr. Taylor, because your ethics have helped us show how much integrity is missing from GAAP-based financial reporting.

Paul B. W. Miller is an emeritus 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 or Accounting Today. Reach them at

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