The Spirit of Accounting
Seven years ago, we published several columns that challenged the accounting profession and regulatory community to get started on updating and otherwise improving the quality of information in financial statements prepared in accordance with GAAP. We labeled current practices with terms that we had produced several years before. The first was Politically Expedient Accounting Principles (PEAP) that are deficient because they're shaped by political pressures and compromises, instead of serving the objective of getting useful information in financial statements. The second was Whatever You Want Accounting Principles (WYWAP) that don't get the job done because they embrace divergent but equally acceptable alternatives, such as FIFO and LIFO. Comparability cannot possibly be achieved with this much diversity, and, without comparability, the information cannot be useful.
The third term, POOP, is explained in this renovated column that criticizes the surprisingly old age of much of GAAP.
Thankfully, some things have changed since this column first appeared. The newly liberated Financial Accounting Standards Board may be finally getting around to ditching some of the standards that have been around for decades, even centuries. For example, Chairman Russ Golden's recent comments show that the board is ready to reconsider measurement and financial statement presentation.
We think you'll agree it's way past time to bring GAAP into the 21st century.
Consider what it would be like if the computer industry had remained content with technology as it existed in the 1970s. We would be using punch cards and reading printouts with fuzzy ink images on wide green-striped pages with little holes along the sides. No computers on every desk, no laptops, no Internet, no e-mail, no digital cameras, no smartphones, no cloud computing, no online commerce, and on and on.
What if your doctor recommended a mustard plaster for your respiratory infection instead of antibiotics? What if your car had to be crank-started and had no air conditioning, cruise control, or remote control key fob? What if the only way you could travel across country was on an open-air train pulled by a coal- or wood-burning steam locomotive?
Our point is that progress, even disruptive progress, is the only constant, and woe unto those who deny it! Commercial activity is always moving ahead to provide better service and serviceability, often at lower prices.
Alas, it seems like the only exception is GAAP. In fact, many practices are so ancient that we call them "Pitifully Old and Obsolete Principles" or POOP.
Since we first wrote about the origins of cost-based depreciation, we've learned that it actually goes back to the 1830s -- that's right, there is an eight in that date! So, how come we're still using it more than 180 years after it became acceptable?
The initial authoritative literature on depreciation appears in ARB 27, which was issued in 1946 and described it in the context of emergency facilities constructed during World War II. That's 68 years ago.
How absurd it is that accountants haven't ever officially considered abandoning this irrational practice of first predicting future events and then reporting as if their projections are real facts. We just can't fathom how they justify pretending that there is something useful about reported financial results based on outdated predictions instead of actual observations.
To be sure, the Accounting Principles Board did reconsider depreciation in 1965 in Opinion 6, but ended up only endorsing it as it was practiced. However, consider the irony of this nearly 50-year-old (and now quaintly optimistic) dissent from a board member (emphasis added): "[Dr. Sidney] 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 be improved through the use of current rather than acquisition costs. In the meantime, strong efforts should be made to develop the techniques for measuring current costs."
In fact, there haven't been even any weak efforts, except perhaps for SFAS 33 in 1979, now 35 years ago. Even then, depreciation wasn't actually observed as the change in an asset's value over a year but was mindlessly calculated by dividing its average current cost by its predicted remaining service life.
Thus, GAAP depreciation is pure POOP that destroys financial statements' usefulness for supporting decisions.
There can be no doubt that business combinations are frequent and significant. Yet what is the state of accounting for them?
Until a few years ago when FASB disallowed what we used to call "pfooling of interests," combination accounting had been virtually unchanged for more than six decades, dating back to 1959 when ARB 51 was issued. When FASB finally acted (over huge protests), all it did was cast in concrete the purchase method, another pitifully old and obsolete practice.
Although the board has improved the purchase method here and there, these efforts have not even begun to wipe away the accumulated dust and grime of the ages. Specifically, the latest version of the purchase method continues to add current and relevant measures of the acquired assets and liabilities to old and irrelevant book values on the acquirer's books. Good information plus garbage still equals garbage.
The obvious route to improved usefulness would combine market value measures of both parties' assets and liabilities. Resistance to this progress isn't justified by reliability issues. After all, if reliable market values can be produced for the acquired company's assets and liabilities, they can also be found for the acquirer's assets and liabilities.
Bottom line, accountants' persistent death grip on purchase accounting is a perfect example of POOP.
Blame for the next item rests squarely on the shoulders of the Securities and Exchange Commission. Specifically, quarterly reporting is so coprolithic (look it up) that it should be the poster child for any campaign to stamp out POOP.
Astonishingly, no one but us seems to have ever cared that the engrained habit of providing financial statements only once every three months has been in place since the early 1930s, when the New York Stock Exchange compelled its member firms to do so. It took another 30 years for the SEC to require registrants to file unaudited 10-Q reports.
Flash forward 50-plus more years to 2014, where investment trades are placed and executed in millionths of a second, where information is instantly available from hand-held phones and tablets all over the world, and where each of those devices has orders of magnitude more capability than the best computers in the world at the time quarterly reporting was mandated.
Who could possibly believe any claims by managers and accountants that they can't provide information more frequently? We suggest that their apologies for this archaic practice are BULL: "Bold and Unbelievably Lame Lies." Their failure to face reality is irrational, unethical and inexcusable.
As a result, we have the bizarre situation where the securities markets' most sought-after information consists of analysts' best guesses of what companies will report. When earnings releases occur, the markets react to them according to their relationship to the predictions, not their actual information content. This is, of course, preposterous.
Space keeps us from going into detail on other examples, but consider this list:
- Treasury stock -- ARB 1, 1939, actually dating back to 1933 (81 years).
- Stock dividends and splits -- ARB 11, 1941 (73 years).
- Inventory and cost of goods sold -- ARB 29, 1947 (67 years).
- Current and noncurrent classifications of assets and liabilities -- ARB 30, 1947 (67 years).
- Equity method -- APB 18, 1971 (43 years).
- Receivables and payables -- APB 21, 1971 (43 years).
- Income statement structure -- APB 9, 1966 (48 years) and APB 30, 1973 (41 years, slightly modified by SFAS 154, which took accounting changes off income statements); also, ASU 2011-05 put comprehensive income on the income statement but we note that not reporting unrealized income as income dates to SFAS 12, 1975 (39 years).
- Research and development -- SFAS 2, 1974 (40 years).
FRAMING THE ISSUE
We've done our part by defining the problem. Who agrees with us and will join us in calling on FASB to stop producing and tolerating bad accounting standards? In an era of phenomenal progress in all kinds of information-based systems, why do financial accountants and managers think the only good ways are the really, really old ways? There is no rational explanation for their obstinance.
We suppose you could say we're just POOPed out.
We are pleased to point out that FASB decided in May to move toward streamlining lower-of-cost-or-market accounting for inventory and eliminating extraordinary income items. We applaud both moves, but urge the board to keep cleaning up all the other POOP.
Paul B. W. Miller is professor emeritus 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.