More times than we can count, we have written that the preferable resolution of most financial accounting issues involves reporting values of assets and liabilities on the balance sheet and changes in those values on the income statement when they happen, not before and certainly not after.We have written about this point in the context of specific items, such as investments, receivables, inventories, tangible and intangible assets, payables, stock options, other derivatives, and pension assets and liabilities. We have also advocated this change on a theoretical level, especially as we reviewed the Financial Accounting Standards Board's new Conceptual Framework project.

Further, we have filled numerous columns (and a book) describing the Quality Financial Reporting paradigm that encourages managers and auditors to respond to demands for information from financial statement users, instead of focusing on their own desires.

That is, most managers suffer from a myopia that leads them to think that manipulating their statements allows them to control the market value of their securities, missing the point that statement users can gather other information from other places and choose to invest or not invest as they wish. Auditors have their own myopia that leads them to think it is enough to audit old dead numbers and announce smugly that the statements comply with generally accepted accounting principles.

Customers first

Alas, it never occurs to most in both groups that a great deal more can be accomplished by actually reporting useful information instead of fabrications and assumptions that make managers look good and help auditors feel safe from recrimination. Of course, the most direct way to find out what users consider useful is to listen to what they say, instead of sticking your fingers in your ears and singing "la la la la" at the top of your lungs.

Recently, Paul Miller had an experience that illustrated this point. He ordered a burrito at the student union and went through the line. Everything was going smoothly as he told the server what he wanted on it, until he asked for lettuce. The person said, "I can't do that!" When challenged, he explained that the chef had told him to never put lettuce on a burrito because that was not the taste the chef was looking for. Never mind what the customer wanted to eat - the issue was what the chef wanted to serve.

For decades, financial reporting issues have been defined, debated and resolved by accountants after listening to other accountants, preparers and auditors. This closed loop has never made any sense, any more than a chef deciding what to put on our burrito.

CFAs speak

Late in October, the Corporate Disclosure Policy Council of the CFA Institute (formerly the Association for Investment Management and Research) issued a report called A Comprehensive Business Reporting Model: Financial Reporting for Investors. This monograph is the long-awaited update of the influential 1993 report entitled Financial Reporting in the 1990s and Beyond. The members of the committee comprise a veritable who's who of well-known and highly experienced financial analysts, and their words should be taken to heart.

The tone of the report is obvious. It speaks boldly and conveys the message that much is wrong with financial reporting. The expressed view is that GAAP-compliant statements contain little information that is useful for users' decisions. The report's centerpiece is a list of 10 "principles" that the analysts propose as the conceptual spine of practice, instead of the status quo. We'll be dealing with several of these principles in the coming months, but we will focus on two in this column.

Before going there, however, we emphasize that what you're about to read is not coming from two head-in-the-clouds, ivory-tower, wild-dreaming accounting professors. It is coming from rock-solid, money-in-the-markets, down-to-earth financial statement users who are tired of spending most of their time unraveling GAAP information and re-engineering it to get a rough idea of what they need to know. They are our profession's customers, and their thoughts must not be ignored.

The first two principles

The first principle asserts basically the same point: "The company must be viewed from the perspective of a current investor in the company's common equity." In other words, managers and auditors are to serve investors, not be served.

The second principle was music to our ears: "Fair value information is the only information relevant for financial decision-making." There it is - an unvarnished demand for revolution. It's no longer a softly put request for values in addition to what's currently reported.

Here are some other quotes:

* "Decisions about whether to purchase, sell or hold investments are based upon the fair values of the investments and expectations about future changes in their fair values. Financial statements based on outdated historical costs are less useful for making such assessments. Fair values, by definition, impound all of the most current assessments about the value of an investment and any future changes in that value." (page 4)

* "Fair value measures reflect the most current and complete estimations of the value of the asset or obligation, including the amounts, timing and riskiness of the future cash flows attributable to the asset or obligation. Such expectations lie at the heart of all asset exchanges. ... If asset exchanges and, indeed, all financial decisions are based upon fair values, then market efficiency requires that the information upon which such decisions are made should be reported at fair value. The implication is that all items in the balance sheet must be reported at current fair value. Furthermore, changes in these values should be reported as they occur in the income statement." (page 12)

Where would this information come from? Read this:

* "With respect to the measurement of fair value, we believe that managers should look first to the most objective sources of fair value, for example, observable prices for the same or similar assets or liabilities in liquid markets. In the absence of such market-determined measurements, managers must report the best estimate of fair value as determined by widely accepted and applied valuation methods and by using market-based inputs." (page 12)

In anticipation of potential objections from traditionalists, the committee says (our emphasis added):

* "Opponents of fair value reporting argue that measuring and recognizing assets and liabilities at fair value in the financial statements introduces volatility into the financial statements. We argue to the contrary: If fair value measurement results in greater volatility, then the measurement has merely unmasked the true economic reality that was already there. Honesty and volatility should not be trade-offs." (page 12)

* "One of the most important evaluations investors must make is to ascertain the degree of risk to which an investment is exposed: the greater the volatility, the greater the risk. The risk is then weighed against the investment's expected returns. Reporting methods that mask true volatility do a great disservice to investors, impair their ability to make well-founded investment decisions, and can result in inefficient allocations of capital." (page 12)

Enough said

This report (available online at is laudable for confirming what accounting theorists have asserted for more than 70 years. It is earth-shattering for those who have buried their heads in the sands of denial, even in this information age. But for those who have the courage to face the future instead of clinging to the past, this report is a clarion call of opportunity.

You can be sure we'll be saying more about it in the weeks and months to come.

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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