The Spirit of Accounting: The Contribution of Educators to the Fall of the Accounting Profession

We're still preoccupied with our project, so here is another encore column from the past. We chose it because of April's earth-shattering revelation that Scott London, the KPMG partner who used to head up the Los Angeles office's audit practice, knowingly released information to a friend who used it to make millions of dollars illegally. London's story came out slowly, first reporting that he made nothing and then something, and next came a video of a clandestine meeting in a parking lot showing him taking an envelope filled with cash.

KPMG immediately dismissed him and labeled him a "rogue," a word with two meanings, with one characterizing him as unprincipled while the other says he acted on his own without direction or supervision. Although he is facing certain punishment, it remains to be seen what repercussions will rock his former firm.

This tragic but avoidable event was a jarring reminder of the seemingly endless streams of accounting frauds from a decade ago that led us to publish this column in July 2003. It is uncharacteristically somber because we confessed our sadness at how accounting teachers have unwittingly encouraged these crimes by not adequately discouraging them.

By now, millions of words have been written about the fall of the accounting profession to its lowest prestige and respected levels in its 100-plus year life. Ominous swells on the financial reporting ocean appeared with frauds at Waste Management, Cendant and Sunbeam. They foreshadowed a tidal wave that rose with Global Crossing and then crested and crashed with a deafening roar with revelations about Enron, Andersen, Tyco, Adelphia, WorldCom, Qwest and now HealthSouth.

An echoing wave has ravaged the investment banking and financial analyst side. Still another has hammered the New York Stock Exchange over the actions of its market makers. And no one should forget how the scandal spread to the Securities and Exchange Commission itself, culminating in Harvey Pitt's resignation after his clumsy efforts to sculpt the Public Company Accounting Oversight Board to meet the needs of those in the profession who put him in office. We cannot fathom how any among us can deny that the accounting world has changed irrevocably from the way it was. So much has been lost through the combined efforts of so many.



When it comes to identifying the causes for this dreadful collapse, it is easy to point fingers at others. For example, the guardians of our ethics code are to blame for letting it be eroded, in content and in enforcement, to the point that it became meaningless; this decline surely weakened the power of auditors to resist their clients' attempts to manage their statements.

Auditors are to blame for selling out their integrity by going to fixed-fee audits and by acquiring clients by first blessing their strange accounting practices and then inventing more deviant methods. The pursuit of consulting and tax fees also added to the fall. Corporate managers are to blame for trying to deceive investors through deficient reporting. Still more blame goes to regulators and Congress for failing to stand for integrity with any real backbone.

All this finger-pointing has already been done. What we want to add is a reproach directed to our own branch of the profession. Why blame academic accountants? Although no one will ever know for sure, we believe that most of, even all, the miscreants were either accounting majors or students with at least one accounting course on their transcripts. If we're right, those who taught them failed to provide the needed foundation. As former Financial Accounting Standards Board member and former SEC chief accountant Walter Schuetze explained once, the capital markets are a figurative crystal vase, highly valuable but dangerously fragile. This vase has been entrusted to the accounting profession for safekeeping, and all that we do must be aimed at protecting it.



For the former accounting students caught up in the scandals, the academic accountants in their lives failed in three ways. First, they did not provide their pupils with a solid appreciation for the capital markets. While there is good reason to consider them to be highly efficient in terms of their ability to understand business and to penetrate GAAP-enabled smokescreens, they aren't perfect. They do get fooled from time to time. As a result, every accountant should be vigilant in doing his or her part to assist the markets in becoming even more efficient.

Another point about the markets that the students were not taught is the clear relationships between the quality of the information in the financial statements, the risk faced by investors, and stock prices. When quality goes down, risk goes up and stock prices go down. Because accounting faculty didn't fully instill these ideas in their students, they conspired (wittingly or unwittingly) in the fraud that has damaged the credibility of all managers and auditors.

Second, we think academic accountants have failed to point out GAAP shortcomings both in public forums and in classrooms. Students need to be taught to evaluate GAAP, instead of just committing it to memory without questioning whether those principles could ever produce useful information.

We're afraid too many of us adopted the attitude that students need to learn GAAP and then get out there and implement it, all without asking whether the output makes any sense (which it often doesn't). Professors who teach GAAP without assessing usefulness surely contributed to the pervasive attitude that GAAP is good enough. Undoubtedly this omission fostered the attitude that financial reporting is a compliance exercise and not a critical information delivery system that anchors our capital markets. The failure to speak out about GAAP shortcomings may have kept auditors from seeing the harm in putting unqualified opinions on totally misleading GAAP financial statements.

Third, it seems to us that our colleagues who instructed these accountants also failed to establish any commitment to our profession's duty to do what is right for the capital markets and the greater economy. Instead, we fear that educators somehow passed on the value that it's suitable, even smart, to elevate individual and firm interests above those of the markets and society as a whole. By this omission, the academics contributed to many poor choices, including the documented decision by Andersen officials to retain Enron as a client despite its aggressive accounting and dubious ethics simply because of the potential to milk the company for $100 million a year.

Putting these three failings together (inadequate teaching about capital markets, GAAP and ethics), we see that some students were turned into weapons of mass destruction. Their pursuit of exaggerated wealth through deception (whether in violation of GAAP or in compliance) destroyed vast quantities of wealth and public confidence in the markets and the reporting system that sustains them.



The same shortcomings are apparent in the inadequate education delivered to non-accountants, primarily higher-level managers in these corporations. It appears they committed two accounting-related sins. First, many attributed too much power to accounting, to the point of thinking that the reported numbers are all that matters, not what is behind them. Their reporting goal came to be publishing favorable numbers, not numbers that reflect what is going on. As Warren Buffett has explained, chief executives who manipulate financial statements run the risk of actually believing those false numbers.

Second, other managers did not attribute enough power to the numbers. Reports just became jokes to be thrown together and sent to the public without regard to the messages they contained. Most often those messages are subliminal signals that managers have no respect for the markets' ability to penetrate accounting ploys. Exhibit A for our case is the virtually unanimous decision to put options expense in the footnotes, instead of the income statement. We blame these managers' instructors for not revealing the dangers in these attitudes while they were in their accounting classes.

Their reporting goal came to be publishing favorable numbers.



Thus, we're convinced that our academic branch of the profession helped knock this huge hole in the bottom of the accounting ship. In all likelihood, we have committed our own sins in this area, but, to our knowledge, neither of us has produced students who have committed fraud to this scale, if at all. We cannot imagine the grief and embarrassment that must be felt by our colleagues who had these people in their classes. Bottom line, the accounting academy needs its own reforms. We hope that we're collectively up to the task and not just hiding our heads in the sand. There is much work to be done to prepare the next generation of managers and accountants so that they don't repeat the transgressions of their predecessors.


To our dismay, we don't think much has changed in the academic world since 2003. Research concerning financial reporting is still almost entirely based on variables taken from published financial statements without criticism or adjustment for their shortcomings because most of the researchers have been taught by others who don't comprehend the discrepancies between what's reported and what's real or don't care about them. Either way, accounting education's future is at risk.

Alas, we don't think the London case will change much. We fear his profs will shake their heads in disappointment and then move on unfazed. In our hearts, we hope they'll engage in introspection to figure out what they need to do different, starting today, to keep it from happening again. We hope a great many others will do the same. We know we are.


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, or the management of Accounting Today. Reach them at paulandpaul@qfr.biz.

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